BA 1320 light workkkk

The Big Players

A world in transition.

In the 19th century, the global economy

was dominated by Europe.

Today, the center of global economic

activity is shifting eastward, toward

Asia and emerging economies.

Economic power is becoming more

global and more diverse

In 1870, the world economy was led mainly by European economies:

United Kingdom, Germany and France.

The United Kingdom was the world’s:

• Leading industrial power

• Leading trading nation

• Leading financial center

At its height, the British Empire became the largest empire in

history.

• It is often described as: “The empire on which the sun never sets”

• Because Britain controlled territories on every continent.

20th Century - The Fall of the British Empire

Empires fall fast…

Although the British Empire reached its largest territorial size after World War I, its economic and political dominance declined quickly.

By the end of World War II:

• Britain had given up most of its colonies

• Britain was no longer the world’s leading industrial power

• Britain was no longer the world’s leading military power

The global leadership role was beginning to shift away from Britain to the U.S.

Post WW2 – US Hegemony (part 1)

Before the 1920s, the U.S was still an emerging economic power.

• Until 1920, the majority of Americans lived in rural areas.

• By the 1930s, the U.S. had already become the largest industrial economy in the world.

WW2 marked the turning point

• Western Europe declined economically due to the war.

• The U.S. was the only major economy to emerge from the war intact and strengthened.

• The U.S. became the world’s leading economic and military power.

Post WW2 – US Hegemony Contd. (part 2)

As the main winner of WW2, the U.S. was in a unique position to shape the post-war global order.

The Bretton Woods system

• Creation of institutions coordinating the global economy and the financial system:

• IMF

• World Bank

• GATT (later the WTO)

• The U.S. Dollar became the anchor of the international monetary system and the main global reserve currency In political science, the 20th century is often called the “American Century.”

Japan after WW2

At the end of WW2, Japan was in ruins.

Japan faced a deep economic and social crisis.

• Most large cities (except Kyoto) were heavily damaged

• Industrial facilities and transport networks were destroyed.

• Severe food shortages continued for several years

But in 1968 Japan becomes the second-largest economy in the world.

Japan’s Rapid Recovery and Industrial Growth

The Japanese economy recovered very quickly in the 1950s and 1960s.

Japan emerged as a major center of heavy and manufacturing industries, especially:

• Steel

• Shipbuilding

• Machinery

• chemicals

By 1968, Japan became the world’s second- largest economy (after the United States).

• Experienced one of the strongest examples of a post-war economic recovery and successful industrial transformation.

Japan - From Heavy Industry to High Technology

The 1973 oil crisis strongly hit the Japanese economy.

• Highly dependent on imported energy.

The response was a strategic shift toward high- technology and high value-added industries.

In the 1980s, Japan became a leading economic and technological power.

• Electronics (e.g. Sony – TVs, video and audio equipment)

• Automobile industry (e.g. Toyota, Subaru)

The very rapid post WW2 economic growth in Japan is known as “The Japanese Miracle.

“Japanese Threat”

In the 1980s, the U.S. and other advanced economies increasingly viewed Japan as a major competitive threat.

The U.S. government, under President Reagan,

pressured Japan to limit its exports to the U.S.

• Threat of imposing tariffs on Japanese exports.

Japan agreed to a Voluntary Export Restraint (VER) on automobile exports to the United States.

• Under the VER, Japan restricted the number of cars exported to the U.S.

• The VER encouraged Japanese firms to shift production to the U.S. (Toyota, Honda, etc.)

The End of the “Japanese Miracle”

Japan’s economic miracle ended in 1989 with the bursting of the stock market and real estate bubbles.

This collapse triggered 3 decades of very low economic growth.

While Japan remained a wealthy and technologically advanced economy, Japan’s influence in the world economy gradually declined.

Japan Gradual decline:

• 2010, China: Overtook Japan to become the second-largest economy by nominal GDP after the US.

• Early 2024, Germany: Overtook Japan to become the world’s third-largest economy, pushing Japan into fourth place (behind the U.S., China, and Germany).

• 2025, India: Rapidly expanding economy grew larger than Japan’s nominal GDP, making India the fourth-largest economy in the world.

2040 Forecast : A New Economic and Political Order

A Historic Shift in Global Economic Leadership

Over the past 30 years, the global economy has transformed:

• From a Europe/developed-centered world (with the U.S., Germany, UK, Japan dominating) to a world where emerging economies drive growth and scale.

• China is forecasted to become the biggest economy, and India the 3rd largest.

Note: Nominal GDP ≠ GDP per capita

• Total GDP shows power and scale, while GDP per capita shows living standards.

• China and India’s total GDP is massive, but average income per person still remains substantially lower than in advanced economies.

Overview of World Population as of 2025

8.2 Billion people

• India –1.46 billion

• China – 1.41 billion

• USA – 347 million

• Euro Zone - 342 million

• Indonesia – 286 million

• Pakistan – 255 million

• Nigeria – 237 million

• Brazil – 213 million

The World Population – Distribution

Most of the world’s population increase since

the 1950s occurred in developing or emerging

economies.

• Improvements in health and reductions in

mortality drove rapid growth in many countries in

Asia, Africa, and Latin America, while birth rates

in developed regions declined earlier and more

sharply.

As of 2026, large majority of the world —

roughly 85% — lives in developing or emerging

economies, with only about 15% living in

developed economies.

• Roughly 36% of the population in China and

India.

Demographic Forecast

In 1950, population concentrated in Asia (55% of world

population) and Europe (~ 20% of world population).

By 2100, only 11% of the global population will live in North

America, Europe, or Oceania combined.

The vast majority of future population growth will occur in

Africa.

• Africa currently holds ~ 16% of the world population.

• By 2100, Africa is projected to have ~4.4 billion people

(~ 39% of world population) — close to Asia’s share

(44%).

By the end of 21st century most of the World population will

live in Asia and Africa.

The Aging of the Population

World population is also aging.

Due to:

• Increase in life expectancy.

• Decrease in women fertility

rates.

Why Is Aging an Economic Problem?

Shrinking working-age populations

• Fewer workers relative to retirees → labor shortages.

• Who will work? Who will produce?

• Weaker growth in labor supply → firms face higher wage pressure and higher production costs.

Slower potential economic growth

• Long-run growth falls when labor force growth declines.

• Aging societies tend to have lower entrepreneurship and risk-taking.

• Public resources shift from investment (education, infrastructure, innovation) toward age-related

spending.

Rising pension and healthcare costs

• Larger elderly population → higher public spending on pensions, long-term care and health

services

• Growing fiscal pressure on governments → higher taxes, higher public debt, or spending cuts

elsewhere.

• Intergenerational tensions as a smaller workforce finances a larger retired population.

Aging by Region (+Forecast)

Population aging is a global

phenomenon, but it is happening

much faster in Europe and North

America.

Asia and Latin America are also aging.

But overall, they remain younger than

Europe and North America

Africa, is the youngest region in the

world.

Demographic Trends and Forecast – Takeaways

1. Future population growth will be concentrated mainly in Africa, while population growth

in Europe, North America and East Asia will remain weak or turn negative.

2. Population aging is a global phenomenon, but it is much more severe in advanced

economies, especially in Europe and North America.

3. Africa is the youngest region in the world, with a rapidly expanding working-age

population.

• This creates strong potential for faster long-run growth — if education, jobs and

institutions improve.

4. Demographics are becoming one of the major drivers of global economic change.—

away from today’s aging industrial economies and toward younger, faster-growing

regions, especially Africa and parts of Asia (for example India).

Case Study: Japan

Japan's population began to decline in

2011.

• Population is expected to shrink to 97

million (24%) by 2050, should the

current demographic trend continue.

But Japan’s real problem is aging.

Japan’s Aging Problem

Ratio of people aged 65 and above has

risen dramatically over the last decades.

By 2050 almost 40% of the population will be

above 65.

Due to:

• High life expectancy – one of the highest in

the world

• Low fertility rate – around 1.15 (2024), one

of the lowest in the world

• Substantially lower than the rate of

substitution.

Possible Policy Responses to the Age Crisis

Possible Policy responses to demographic decline

include:

1. Government policies to boost fertility

• Policies include child allowances, subsidized childcare,

parental leave, and housing support.

2. Immigration

3. Technology and automation

• Automation and AI can partly offset labor shortages and

raise productivity.

Japan’s Population Crisis – Solution 1

Japan illustrates the limits of all three policy responses:

1. Government policies to boost fertility

• Policies include child allowances, subsidized childcare,

parental leave, and housing support.

• In practice, these policies have only limited effects on

birth rates.

• Japan faces many barriers:

• Long and inflexible working hours

• High career penalties for women after childbirth

• Persistent gender norms in childcare and household

work

• Result: even generous family policies have not

reversed low fertility.

Japan’s Population Crisis – Solution 2

Japan illustrates the limits of all three policy responses:

2. Immigration

• Immigration is one of the most effective tools to

stabilize the workforce in aging societies.

• For Japan, this solution is particularly difficult:

• Strong social and political resistance to large-

scale immigration

• Result: Compared to Europe or North America,

Japan has very limited scope to rely on

foreign workers.

Japan’s Population Crisis – Solution 3

Japan illustrates the limits of all three policy responses:

3. Technology and automation

• Automation and AI can partly offset labor shortages

and raise productivity.

• Japan is a global leader in robotics and automation.

• However: many growing sectors (health care, elderly

care, services) are difficult to automate.

• Result: Technology cannot fully replace the scale

of labor lost through population decline.

Germany’s Solution

Germany, Europe’s largest industrial economy, faces

pronounced population aging and a shrinking workforce.

Unlike Japan, Germany has admitted large numbers

of immigrants and refugees to help offset labor

shortfalls and support its economy.

Despite economic needs, immigration has become

politically contentious in Germany.

This tension reflects a broader trade-off:

• Economic dependency on immigration vs.

political resistance to it.

Economic Growth Over the Centuries

Economic growth is a new phenomenon.

For most human history until around 1800,

world output is very low and almost flat.

During the 20th century, especially after 1950,

GDP rises extremely fast

World Trade Over the Centuries

World trade has grown dramatically

since around 1850.

• Slow and steady growth until mid-20th

century.

Rapid acceleration after 1950, especially

post-1980s.

• Temporary dips visible around global

crises (e.g.,2008 financial crisis, COVID-

19)

Four Industrial Revolutions

First Industrial Revolution:

Late 18th to Late 19th Century

Catalyst of the first Industrial Revolution:

• Steam Engine

Historical Impact:

• Fueled the British Industrial Revolution.

• Enabled Great Britain to dominate global trade (British

Empire).

Economic Transformations:

• Machine power substantially enhances human labor→

significant economic growth.

• Railways transported goods over long distances →

Accelerated globalization and international trade.

Second Industrial Revolution:

Late 19th Century to Mid 20th Century

While the First Industrial Revolution gave us machine power, the Second

Industrial Revolution made production scalable, standardized, mobile, and

connected, through several major inventions:

Electricity & Power

• Widespread use of electricity → powered factories, street lighting, and homes

Materials and industrial production

• Modern steel production (Bessemer process)

• Steel became much cheaper

• Enabled railways, bridges, skyscrapers and heavy machinery

• Standardization and mass production

Transportation Technologies:

• Development of internal combustion engines → cars, airplanes, and machinery

• Growth of commercial shipping and aviation.

Communication technologies

• Telephone, radio, and later TV.

Transportation and Communication Costs

• Decline in transport costs

• New technologies made

ships, ports and rail

systems much more

efficient — setting the

stage for the long-run fall

in sea freight and

passenger transport

costs.

• Decline in communication

costs due to new

communication technologies.

Third Industrial Revolution:

1970s to Recent Years

Production becomes increasingly driven by information

The principal innovations:

• Computers (PC) - information can be stored and

processed at scale

• Internet - information can move instantly across

countries

• Automation - machines increasingly operate using

digital instructions

• Industrial robots and computer-controlled

machines (CNC)

Communication Costs

• The second industrial revolution

mainly transformed physical

transport, while the third industrial

revolution revolutionized

communication.

• The dramatic collapse in international

communication costs is driven by

digital and information technologies —

satellites, fiber-optic cables, computers

and the internet.

Example 1:Online Retail

Online shopping expanded rapidly

• From around 1% of retail sales in 2000 to around 15%

by 2025.

• COVID accelerated this transformation.

Online shopping does more than replace

physical stores

• It reduces transaction costs and search cost.

• Consumers can compare prices instantly and access

more products.

• Lower costs strengthen competition and can increase

economic activity.

Online shopping also changes globalization

• Consumers are no longer limited to local markets.

• Lower communication costs increase international trade

and connect economies.

Example 2: Outsourcing

Outsourcing is the practice of relocating certain production processes or services to

external firms, often in other countries, to reduce costs or increase efficiency.

• Manufacturing:

• Design in the U.S. or Europe, production in East Asia.

• Services:

• Call centers, accounting, and customer support outsourced to India or the

Philippines.

• Software & IT services:

• Global teams collaborating in real time via online platforms.

• Business processes:

• Payroll, HR, data processing handled remotely.

Results:

• IT made distance economically irrelevant, allowing to break production

into stages and locate each stage where it could be done most efficiently.

• Lower costs, greater efficiency, and deeper globalization — but also

stronger competition and unequal effects across workers.

Example 3:Financial Markets

T transformed financial markets from largely national systems into a globally integrated network.

Then (1970s):

• Financial markets were mostly national

• Investment opportunities and capital raising were largely local.

Today:

• Financial markets are globally integrated

• Capital and information move quickly across countries

Why does this matter economically?

• Capital can move to where investment opportunities are strongest

• More investment supports business growth, innovation, and development

• Financial integration became one of the key forces supporting globalization

Tradeoff:

• Greater financial integration creates more opportunities — but also increases exposure to global financial

shocks

Forth Industrial Revolution

While many economists view the Fourth Industrial

Revolution as a continuation of the Digital (Third)

Industrial Revolution rather than a completely new

technological break, there is one important distinction.

• The Third Industrial Revolution connected the world

digitally.

• The Fourth Industrial Revolution makes machines

intelligent and increasingly autonomous.

Major inventions:

• Cloud Computing

• 3D printing

• Robots

• Artificial Intelligence (AI)

Technology and Labor Markets

Technology is rapidly

transforming the workforce

in developed economies,

placing about 30% of jobs at

risk by the early 2030s.

US Employment by Sector over Time

Long-run structural transformation of

employment:

• Labor shifts from agriculture →

manufacturing → services

(“other”) as U.S economy

developed.

US Employment by Sector – Conclusions

Long run massive unemployment as Doomsday forecasts predicted never occurred.

• Agriculture:

Two hundred years ago, about 80% of the workforce was employed in agriculture. Today, that

number has fallen to roughly 2%, largely due to technological progress and productivity gains.

• Manufacturing:

Manufacturing employment initially expanded during industrialization but has been declining over

the past several decades. Many of these workers have borne the costs of globalization—

particularly job outsourcing—and technological change.

• The shift to services:

At the same time, entirely new sectors and occupations have emerged, most notably in the

service sector, absorbing much of the labor released from agriculture and manufacturing.

Long-Run US Employment – Conclusions

Past industrial revolutions reshaped labor markets, triggering major transitions in the types of

jobs people did.

• They created demand for entirely new industries—many of which are now service-

based.

• Despite short-term disruptions, these revolutions did not lead to permanent,

widespread unemployment; over time, workers moved into new roles.

Overall, economies and societies benefited from these transformations!!!

• Productivity rose, and national wealth increased.

Yet…

• Unlike the First and the Second Industrial Revolutions, the Third Industrial Revolution

has not been inclusive.

• It has primarily benefited high-skilled workers.

While many people can work in a factory or drive a car, not everyone can become

an engineer…

The Polarization of the Labor Market – Conclusions

Rising demand for high-skilled workers

• High-skilled jobs require higher education and specialized knowledge

• e.g., engineers, programmers, technical professionals

• Technology complements these workers and makes them more productive.

Rising demand for low-skilled workers

• Low skilled jobs are primarily service jobs.

• e.g., food service, personal care, cleaning, delivery

• These jobs are difficult to automate.

• Demand also increases as higher-income households consume more

services.

Declining demand for middle-skilled workers

• Industrial jobs (e.g., auto manufacturing, mining), Office and administrative

jobs

• These occupations involve routine, repetitive tasks that can increasingly be

automated or programmed.

• As a result, demand for middle-skilled workers declines.

“Downgrading”

People who worked in

middle skilled jobs cannot

find high skilled jobs.

• They don’t have the

skills.

• They are pushed to

low paying jobs -

“downgrading”

The Polarization of the Labor Market – Conclusions

• The Third Industrial Revolution did not lead to mass unemployment.

• Instead, it reshaped labor demand — growing at the top and bottom

while shrinking in the middle.

• The U.S. economy as a whole benefited from the Third Industrial

Revolution.

• The average American became richer, and the country overall became

more prosperous.

• However, these gains were not shared equally.

• A large part of the adjustment cost was borne by middle-skilled

workers

The Polarization of the Labor Market:

A Global Phenomenon

The polarization of the job market is a

global phenomenon.

Demand for medium skill workers decreased

in all EU countries

Routine jobs are disappearing

Wage Polarization and Income Inequality –

Conclusions

1960s–1970s:

• Broad economic growth – real wages increased across all education groups.

Since the 1980s:

• The pattern changes – wages become increasingly unequal.

• High-education workers continue to experience strong wage growth;

• Middle-education workers experience slower growth or stagnation;

• Low-education workers experience declining real wages (particularly among men).

Conclusions:

• The Third Industrial Revolution rewarded workers whose skills complement technology.

• Higher income inequality and increasing labor market polarization.

• Economic growth continued —but the gains were distributed much less equally across

workers

4th Industrial Revolution – The AI Revolution

AI can perform tasks that are associated with

human cognitive skills.

Traditionally, new technology made the most

educated higher skilled workers more

productive, while replacing lower skilled

workers.

AI has the potential to disrupt some highly

paid jobs, while some low skilled jobs are

actually at low risk.

AI – A Game Changer? – Part 1

High skilled jobs that are at risk:

• Legal services

• Accounting

• Financial advisors

• Engineers

AI – A Game Changer? – Part 2

At least in the foreseeable future jobs that are not at risk

Very creative jobs

• Chorographers

Jobs that require human contact or empathy:

• Psychologists

• Nurses

Manual jobs that are not repetitive or predictable:

• Janitors

• Gardeners

• Plumbers

• Electricians

AI – A Game Changer? – Part 3

Most often there will be tasks within the jobs that

will be replaced by machines:

• AI will not replace humans but humans with AI will

replace humans that don’t use AI.

• Software engineers, doctors, etc. will become

more productive.

• Entry level jobs are at risk

Technology and Labor Markets – Summary Notes

• At present, the US workforce lacks the skills

required to undertake the highly technical

and specialist work of future labor market.

• Political will and investment will be crucial

for the US government, working hand in

hand with universities and companies, to

train the next generation of employees

• US spending on public and private training

currently trails behind its industrial

competitors at less than 1 per cent of GDP.

The Importance of GDP

Why is GDP so important for economists?

• GDP measures a country’s economic size

and productive power.

• GDP summarizes many deep forces in one

number.

Technology, institutions, globalization, wars,

and industrialization all show up in long-run

GDP trends.

• GDP helps explain global power and

historical change.

• The rise and fall of countries in world history

closely follows changes in their GDP.

• If you follow GDP over time, you can already

tell a large part of the story of the world!

Definition: Gross Domestic Product

Gross Domestic Product (GDP) is the…

• Total market (dollar) value of all final goods and services

• Produced within a country

• During a given period (year, quarter)

GDP is an estimate of a country’s total economic output and total income.

GDP does not include:

• Unpaid work – stay-at-home parents

• Underground economy/illegal activity.

• Sales of used (second-hand) goods

• Pure financial transactions (e.g. buying stocks and bonds — no new production)

• Government transfer payments (e.g., unemployment benefits, pensions – no new production)

Criticisms of GDP

Some valuable activities are not included:

• Unpaid work such as childcare, elder care, and household production creates real

economic value, but is not counted in GDP.

Environmental costs are largely ignored:

• Economic activity that damages natural resources raises GDP today, even if it reduces

future living standards.

Some spending raises GDP even if it reflects social problems:

• For example, spending on security systems, private protection, prisons, or pollution

clean-up increases GDP, even though it may reflect crime, insecurity, or

environmental damage, not genuine improvements in wellbeing.

Criticisms of GDP – Part 2

GDP does not show how income is shared

• GDP can grow even when most of the gains go to a small group.

GDP does not capture many aspects of quality of life

• Health, safety, free time, job security, social connections and trust matter for wellbeing, but are

only weakly reflected in GDP.

This limitation was recognized from the start!

• Even Simon Kuznets, one of the founders of national income accounting, warned that national

income measures should not be confused with social welfare.

Criticisms of GDP – The Bottom Line

GDP is not a perfect measure of wellbeing — but it remains the international standard

measure of economic activity.

This is why organizations such as the United Nations recommend using GDP together with

additional wellbeing and sustainability indicators, rather than replacing it.

Nominal GDP vs. Real GDP

Nominal GDP – value of current

production at current market prices

Real GDP – value of current

production at base year prices

(constant prices)

GDP Deflator

(Nominal GDP / Real GDP) * 100

GDP deflator is a measure of price inflation/deflation with respect to a specific base year.

US Nominal vs. US Real GDP

• Blue line (Nominal GDP): GDP measured at

current prices (includes inflation)

• Red line (Real GDP): GDP measured at constant

prices (inflation removed).

• The gap between nominal and real GDP reflects

inflation

• Nominal GDP is steeper due to inflation.

• The two lines coincide in 2005 because 2005 is the

base year (2005 = 100).

• Both series rise over time, showing long-run

economic growth.

• The drop around 2008–2009 reflects the global

financial crisis.

Per Capita GDP

GDP / Population

• Measures the average level of income in a country.

• Helps compare living standards across countries.

• Does NOT reflect income distribution (e.g., inequality).

Countries by GDP Per Capita

• Developed economies — mainly in

North America, Western and Northern

Europe, and Oceania — tend to have

the highest GDP per capita.

• Countries with the lowest GDP per

capita are concentrated mainly in Sub-

Saharan Africa.

GDP vs. GDP (PPP)

There are two ways to measure GDP of different countries and compare

between them.

1. GDP (at exchange rate) – when the currencies of all countries are

converted into USD.

• Nominal or Real GDP are GDP at exchange rate

2. GDP (PPP) or GDP at Purchasing Power Parity (PPP)

• Accounts for the absolute purchasing power of each country’s currency.

• Purchasing Power Parity (PPP) is measured by finding the value (in USD) of a basket

of consumer goods that are present in each country.

• Reflects living standards and real consumption capacity better than GDP at

exchange rate.

GDP vs. GNP

Gross National Product (GNP) is the...

• Total market value of all final goods and services produced in a given period

• From factors of production owned by a country’s citizens.

GNP: Factors of production owned by a country’s citizens, anywhere in the world.

GDP: Production within a country (domestic)

GDP vs. GNP – When Does It Matter?

1. Countries with many citizens working abroad (GNP > GDP)

• Philippines: Millions of overseas workers send remittances home.

• Domestic production (GDP) is smaller than the income earned by citizens abroad.

• India: Large diaspora working in the Middle East and US.

2. Countries with large foreign-owned production (GDP > GNP)

• Ireland: Many multinational corporations (tech, pharma) operate there.

• Much of the profits go to foreign owners, not Irish citizens.

In these cases, GNP is often more informative than GDP, because it captures the

income that finally stays with the country’s citizens

What Is Economic Growth?

Growth – An increase in Real GDP occurring over time.

• Measures growth in total output of the economy.

Per Capita Growth - An increase in Real GDP per person occurring over

time

• Measures growth of average income/standard of living

Measuring Economic Growth

gt = (y1-yt-1 / yt - 1) x 100

- Where yt is real GDP (or Real GDP per capita) in year t.

- Example: Year Real GDP /Real GDP per Capita

2025 $15,000

2026 $15,500

g = (15,500 - 15,000/15,000) x 100 = 3.33%

Growth vs. Per Capita Growth

GDP growth shows the economy is producing more overall but doesn’t tell us if people are actually

better off.

Per capita GDP growth reflects average income and living standards, which directly affects

people's quality of life.

• Per capita growth is positive if GDP grows faster than the population.

In countries with rapid population growth, total GDP can increase even if per person income falls.

Policymakers focusing only on GDP growth may overlook declines in individual well-being.

Long-Run Trend vs. Short-Run Fluctuations

• In macroeconomics, we distinguish between

the long-run trend and short-run

fluctuations around the trend.

• Business Cycles – are short-run fluctuations

in economic activity around the trend line.

→ They mainly matter for short-run

economic conditions (recessions and

booms).

• Macroeconomics is also concerned with the

long-run effects of economic growth —

represented by The Trend Line.

Long-Run Growth

• Long-run economic per capita growth is a

relatively new phenomenon.

• Until around 1830 world per capita GDP was roughly

constant.

• In the 20th century, growth became very rapid

(close to exponential).

• The era of fastest per capita growth: 1945 (end

of WW2) and until 1973.

Growth: A New Phenomenon in Human History

• For most of human history, the

economy was essentially frozen.

• GDP per capita was essentially

stagnant.

• Why?

• Land is the main input in

production, and land is fixed

in supply.

The Catalyst: Industrialization

• 1712: Tomas Newcomen developed the first

commercial steam engine.

• 1781: James Watt radically altered the steam

engine.

• This allowed a movement from production

by hand to production by machines.

• With machines each worker can produce

more.

• Labor productivity increases

Pre Modern Era: Limited Credit

• In the pre-modern economy, access to

credit was very limited.

• Without credit, people were trapped in a

vicious cycle that kept the economy

stagnant.

A Modern Economy: A Lot of Credit

• With more credit → more investment

→ more production

→The economy grows

Credit in Early Societies – Why Was It So Limited?

• Some form of credit existed in almost all known human

societies, as far back as Sumer.

• However, only limited amounts of credit were available, and

loans were usually short-term and carried very high interest

rates.

• Why?

• There was little trust in the future.

• In a non-growing world, lending is much riskier.

• People believed that total wealth was fixed — the

economy was seen as a zero-sum game, an unchanging

pie.

Why Is There More Trust in the Modern Era?

• The Industrial Revolution introduced, for the first

time, the idea of sustained progress.

• This idea of progress quickly spread to economics.

• Trust in the future creates credit, and credit

creates growth — the economic “pie” is growing.

• Today, trust in the future is high enough that banks

can keep very small reserves, extend large amounts

of credit, and offer long-term loans at relatively low

interest rates.

A Modern Era: A Lot of Credit

• More trust → more credit → more

investment → more production → more

growth.

• In times of economic crisis, trust falls, credit is

reduced, and economic growth slows.

Growth and Standard of Living

• Economic growth over the last two centuries has dramatically improved

the human condition:

• Higher life expectancy.

• Higher literacy level and education

• Lower child mortality.

• Humans are better fed, clothed and housed.

Child Mortality

• In 1800, child mortality rates were extremely

high — more than 40% of the children did not

survive past age 5.

• Industrialization, improved nutrition, sanitation,

and healthcare dramatically reduced child deaths.

• Today, global child mortality is a fraction of

what it was 200 years ago.

• Child Mortality in developed countries is much

lower than 1%

• Brazil and China have reduced child mortality

rates tenfold over the last four decades.

• In Sub-Saharan Africa, child mortality has

been continuously falling for the last 50 years

— in the early 1960s, 1 in 4 children died

before age 5; today, it is less than 1 in 10.

Life Expectancy

• Over the last 200 years, life expectancy

has increased dramatically.

• In Europe, life expectancy has doubled and

now exceeds 80 years.

• Huge differences remain between countries.

• In Sub-Saharan Africa, life expectancy is

still below 60 years.

• In Japan, life expectancy exceeds 80

years.

Literacy

• 1800s: Literacy was limited — only a

small fraction of the population could read

and write.

• Today: Global literacy is over 85%, with

near-universal literacy in developed

countries.

Literacy – Part 2

• Regional gaps remain: Sub-Saharan

Africa and parts of South Asia still have

lower literacy rates, but progress

continues.

• Recent decades: The drop in global

illiteracy is largely driven by

emerging economies investing in

education.

Poverty

• 1820: World population just under 1.1 billion; over 1

billion people lived in extreme poverty.

• Until the 1970s: Poverty decline was too slow to

keep up with population growth.

• Absolute number of poor people increased,

even though the share of the population in

poverty declined.

• Since the 1970s: Absolute number of people in

extreme poverty is falling, despite rapid population

growth.

• Today: Less than 10% of the global population

lives in extreme poverty.

Poverty – Part 2

• 1970: 2.2 billion people living in extreme

poverty.

• 2015: 705 million people living in extreme

poverty.

• Global impact:

• Asia: Largest reduction in poverty.

• Sub-Saharan Africa: Most of the

world’s extreme poor today.

• Interesting fact: Both regions

started at similar poverty levels

in the 1970s

The Rule of 72

• Shows the number of years required for an economy to double, at a given annual rate of growth

• 72 ÷ annual % growth ≈ Years to double value

• An economy growing at 2% per year will double its GDP in about 36 years.

• (72 ÷ 2 = 36)

• An economy growing at 7% per year will double its GDP in just over 10 years.

• (72 ÷ 7 = 10.3)

• An investment earning a 4% annual return will double in value in about 18 years.

• (72 ÷ 4 = 18)

U.S. vs. China GDP & Growth

• China will finally take over the US, because

its economy is growing much faster!

• In terms of GDP (PPP), China has been the

largest economy in the world since 2014.

Economic Growth and Inequality

For years, the dominant narrative emphasized

globalization’s success in boosting global growth

and reducing poverty.

• As long as growth was strong, its distributional

consequences received little attention.

The Great Recession of 2008 changed this

perception.

• It exposed that globalization and technological

change raised global incomes — but the gains were

very unevenly distributed

The Elephant Chart

Who gained and who lost from

global income growth during

the two decades before the

Great Recession?

How to read the chart?

•X-axis: Global income

percentile

(poorest → richest individuals

worldwide).

•Y-axis: Growth in real income

(%)

•Each point shows income

growth for a specific global

income group.

The Elephant Chart – Part 2

The back (emerging economy middle class)

• Strong income growth for people in China, India,

and other emerging economies

The dip (advanced-economy middle class)

• Stagnant or very low growth for middle-income

workers in rich countries

The trunk (global top 1%)

• Extremely high-income growth for the global rich

Conclusion: Global inequality between countries

fell, while inequality within many rich countries

increased.

The Middle Class in Industrialized Economies

While economic growth continued, job security and wage

growth for the middle and lower-middle class weakened.

What happened?

• Disappearance of middle-skill jobs.

(manufacturing, clerical, routine office work)

• Rising job polarization.

(growth in high-skill and low-skill jobs)

Why?

• Technology & automation (major reason).

• Routine tasks replaced by machines and software.

• Outsourcing & global competition

• Production shifted to lower-cost emerging economies.

A Closer Look at the U.S. : The Shrinking Middle Class

Left Figure: Median income grew for all groups,

but much faster at the top.

Right Figure: The middle class's share of total

income is shrinking.

• From 1970 to 2018, the share of aggregate

income going to middle-class households fell

from 62% to 43%.

• Over the same period, the share held by upper-

income households increased from 29% to 48%!

Conclusion:

• Economic growth continued, but its benefits

increasingly accrued to the top.

• The middle class did not disappear — but it

lost economic ground.

Measure of Income Inequality: Lorenz Curve

The Lorenz curve is a graph that shows how income (or

wealth) is distributed across a population.

How to draw it?

• The horizontal axis shows the cumulative share of the

population, ordered from the poorest to the richest.

• The vertical axis shows the cumulative share of total

income.

• The 45° line is the line of absolute (perfect) equality.

• Along this line, the bottom x% of people would earn

exactly x% of total income.

Lorenz Curve - Example

Example:

• The poorest 20% of the population receive only about

5% of total income.

• First quantile – 5% of total income

• The poorest 40% receive about 14%.

• Second quantile – 9% of total income.

• The poorest 60% receive about 30%.

• Third quantile – 16% of total income

• The poorest 80% receive about 53%.

• Fourth quantile – 23%

• Fifth quantile – 47%

This Lorenz curve Indicates substantial income inequality

• Top quantile earns about 9 times more than bottom

quantile.

How to Compare Two Lorenz Curves?

The farther the Lorenz curve is from the 45° line, the greater the inequality.

• At perfect equality, Lorenz curve coincides with the line of equality.

• At maximum inequality, Lorenz curve lies along the axes and jumps to 100% at the last

person.

Measure of Income Inequality: Gini Coefficient

The Gini coefficient (also Gini index or Gini ratio) is the most

used measure of income distribution.

It’s directly related to the Lorenz curve.

• Measures the area between the Lorenz curve and the line

of perfect equality, relative to the total area under the line of

perfect equality:

• It is a ratio between 0 and 1.

Gini coefficient = A / (A + B)

Combining Lorenz Curve and Gini Coefficient

G = 0 → perfect equality (everyone has the same income)

• Lorenz curve coincides with the line of equality.

G = 1 → maximum inequality (one person has all the income)

• Lorenz curve lies along the axes and jumps to 100% at the last person

Lorenz curve closer to the diagonal → smaller area → lower Gini → more equal

Lorenz curve more bowed → larger area → higher Gini → more unequal

Gini Coefficient – International Comparison

• Income inequality is generally higher in Sub-Saharan Africa and Latin

America than in other regions of the world.

• South Africa ranks as the country with the highest level of income

inequality in the world - Gini coefficient of 63/100 (2014 data).

• In South Africa, the richest 10% hold 71% of the wealth

• The poorest 60% hold just 7% of the wealth.

• More than half of South Africa’s population lives in poverty.

• The United States has the highest level of income inequality in the

developed world

• Income inequality is generally lower in Europe than in other regions of

the world.

• Nordic and Central & Eastern European countries are the most equal

(7 out of 10 most equal countries)

The Redistributive Role of Taxes and Transfers

In modern economies taxes and transfers are the main tools

used to decrease income inequality.

• Taxes - compulsory payments collected by the government

from households and firms to finance public spending.

• Money the government collects from people and

firms.

Transfers - payments made by the government to individuals or

households without receiving goods or services in return, usually to

support income.

• Money the government gives to people and firms.

• Examples: unemployment benefits, Social Security

(retirement and disability benefits), food stamps.

The Redistributive Role of Taxes and Transfers – Part 2

Taxes and transfers move income from higher-income

groups to lower-income groups, reducing the gap between

rich and poor.

• Taxes reduce households’ disposable income,

especially for higher-income households.

• Transfers and social benefits increase the

disposable income of lower-income households.

Together, taxes and transfers change the distribution of

income and therefore reduce overall income inequality.

Figure: Income inequality is lower after taxes and transfers