Principles of Macroeconomics - Chapter 11: Growth

Economic Growth

Sustained increases in real GDP per capita over time.

Real GDP per Capita

Real GDP divided by population; commonly used to compare living standards across countries and over time.

Why Does Long-Run Economic Growth Matter?

Small differences in annual growth rates can produce very large differences in living standards over long periods.

When Did Most Worldwide Economic Growth Occur?

Within roughly the last two centuries.

Industrial Revolution

The application of mechanical power to the production of goods, beginning in England around 1750.

Effect of the Industrial Revolution

It produced sustained increases in real GDP per capita and long-run economic growth.

Why Did the Industrial Revolution Begin in England?

The slides emphasize stronger property rights, protection of wealth, an independent court system, and limits on arbitrary government actions.

Property Rights and Growth

Strong property rights encourage entrepreneurs to invest because they expect to keep the benefits from their investments.

Slow Economic Growth

A country that grows too slowly fails to significantly raise its standard of living.

Small Growth-Rate Differences Over Time

Even seemingly small differences in annual growth rates can create very large differences in income over decades.

Developed or High-Income Countries

Industrialized countries with relatively high levels of real GDP per capita.

Developing Countries

Countries with relatively lower levels of real GDP per capita.

Newly Industrializing Countries

Countries that have transitioned toward higher income and greater industrialization, such as Singapore, South Korea, and Taiwan in the slides.

Income and Living Standards

Higher income generally improves living standards, although health, education, technology, and knowledge can also improve living standards.

Economic Growth Model

A model explaining long-run growth rates in real GDP per capita.

Labor Productivity

The quantity of goods and services produced by one worker or by one hour of work.

Two Main Determinants of Labor Productivity

Capital per hour worked and the level of technology.

Capital per Hour Worked

The amount of capital available to workers for each hour of work.

Technological Change

A change in a firm's ability to produce a given level of output with a given quantity of inputs.

Three Main Sources of Technological Change

Better machinery and equipment, increases in human capital, and better organization and management of production.

Human Capital

The accumulated knowledge and skills workers acquire through education, training, and life experience.

Better Machinery and Economic Growth

Improved equipment allows workers to produce more output per hour.

Human Capital and Economic Growth

More knowledge and skills make workers more productive.

Better Organization and Economic Growth

Improved management and production methods can increase labor productivity.

Just-in-Time System

A production system in which parts arrive at the factory exactly when they are needed.

Per-Worker Production Function

The relationship between real GDP per hour worked and capital per hour worked, holding technology constant.

Diminishing Returns

Additional increases in capital produce progressively smaller increases in output.

Why Does Capital Have Diminishing Returns?

When workers already have large amounts of capital, adding another unit of capital increases output by less than earlier additions.

Capital in a Capital-Poor Country

Additional capital can greatly increase productivity because the country begins with relatively little capital.

Capital in a Capital-Rich Country

Additional capital has a smaller effect because of diminishing returns.

Technological Change and the Production Function

Technological progress shifts the per-worker production function upward.

Why Is Technological Change Important for Long-Run Growth?

Increasing capital is limited by diminishing returns, while continued technological change can keep raising productivity.

Long-Run Increase in Living Standards

According to the Solow model presented in the slides, continued increases in living standards require continuing technological change.

Solow Growth Model

A model developed by Robert Solow emphasizing capital accumulation, diminishing returns, and technological change.

How Did Solow Treat Technological Change?

Solow did not explain its source; technological change was treated as resulting from outside or chance scientific discoveries.

New Growth Theory

A model emphasizing that technological change responds to economic incentives and the operation of the market system.

Paul Romer

Economist associated with new growth theory and the importance of knowledge capital.

Knowledge Capital

Knowledge accumulated through research, development, innovation, and technological advances.

Physical Capital

A rival and excludable type of capital subject to diminishing returns.

Knowledge Capital as a Public Good

Knowledge is largely nonrival and nonexcludable, allowing benefits to spread throughout the economy.

Rival Good

One person's use reduces the amount available for others.

Nonrival Good

One person's use does not prevent others from using it.

Excludable Good

People can be prevented from using the good if they do not pay.

Knowledge Capital and Increasing Returns

New knowledge can benefit many firms and workers, producing increasing returns at the economy-wide level.

Free Riding

Benefiting from a good or service without paying for it.

Knowledge Capital and Free Riding

Firms may create less knowledge than is socially desirable because other firms can benefit from their discoveries.

Government Role in Knowledge Capital

Protect intellectual property, subsidize research and development, and subsidize education.

Patent

An exclusive legal right to produce a product for 20 years from the date the patent application is filed.

Purpose of Patents

To give innovators an opportunity to profit from inventions while eventually allowing society to benefit from them.

Copyright

Legal protection giving creators exclusive rights over creative works.

Why Protect Intellectual Property?

It increases the incentive for firms and individuals to invest in research, development, and innovation.

R&D Subsidies

Government support for research and development through direct research, grants, or tax incentives.

Education Subsidies

Government support for education that helps increase human capital and the supply of technically trained workers.

Creative Destruction

Joseph Schumpeter's idea that new products and technologies replace older products, industries, and production methods.

Example of Creative Destruction

The automobile replacing horse-drawn carriages.

Joseph Schumpeter

Economist who emphasized entrepreneurs, innovation, profits, and creative destruction as central to economic growth.

Entrepreneur's Role in Growth

Entrepreneurs combine labor, capital, and natural resources in new ways and introduce innovations.

Profit and Innovation

Expected profits give entrepreneurs an incentive to introduce new products and production methods.

U.S. Productivity Growth Before 1900

Relatively modest compared with much of the twentieth century.

U.S. Productivity Growth and R&D

Investment in research and development contributed to higher productivity growth during much of the twentieth century.

Productivity Slowdown

A decline in U.S. productivity growth beginning around the mid-1970s.

Optimistic View of Productivity Growth

Recent productivity may be understated because modern services and technological improvements are difficult to measure.

Pessimistic View of Productivity Growth

The productivity slowdown may represent a persistent long-run decline, with only temporary boosts from information technology.

Why Is Service Output Difficult to Measure?

Changes in convenience and quality may benefit consumers without being fully captured in GDP statistics.

Consumer Surplus and Modern Technology

Services such as ATMs, internet communication, and free online information create benefits that may not be fully measured in GDP.

Information Technology and Productivity

Computers, faster data processing, cell phones, and the internet helped raise productivity.

Artificial Intelligence and Productivity

The slides state that AI has the potential to increase productivity across many sectors.

Secular Stagnation

The idea that economic growth may remain persistently slow for a long period.

Catch-Up

The prediction that poorer countries' GDP per capita will grow faster than richer countries' GDP per capita.

Convergence

The process through which poorer countries grow faster and move toward the income levels of richer countries.

Why Should Poor Countries Grow Faster?

They gain more from additional capital and can adopt technologies already developed in richer countries.

Evidence for Catch-Up Among High-Income Countries

Initially poorer high-income economies such as Korea and Hong Kong grew faster than some initially richer economies.

Does Catch-Up Occur Everywhere?

No. The slides show that many low-income countries have failed to converge with richer countries.

Why Might the U.S. Remain Ahead of Other High-Income Countries?

Relatively flexible labor markets, faster technology adoption, efficient financial markets, venture capital, and historically less interference with market outcomes.

Flexible Labor Market

A labor market where hiring and firing are relatively unrestricted, making it easier for resources to move toward productive uses.

Venture Capital

Funding supplied to new or growing businesses, helping innovative firms obtain capital.

Four Main Reasons Many Poor Countries Grow Slowly

Weak institutions, wars and revolutions, poor public education and health, and low saving and investment.

Weak Institutions

Poorly functioning political, legal, or economic systems that discourage investment and entrepreneurship.

Rule of Law

The government's ability to enforce laws, especially laws protecting property and contracts.

Rule of Law and Growth

Strong enforcement of laws and contracts gives entrepreneurs confidence to invest.

Independent Court System

A court system capable of enforcing contracts without improper political interference.

Property Rights

The rights individuals or firms have to exclusively use, buy, or sell their property.

Why Are Property Rights Important for Growth?

Entrepreneurs are less likely to invest if they fear their property or profits may be taken.

Corruption and Economic Growth

Corruption weakens incentives to save, invest, start businesses, and enter financial contracts.

Wars and Revolutions

Conflict discourages investment and makes technological and economic development more difficult.

Public Education and Growth

Better education increases human capital and worker productivity.

Public Health and Growth

Healthier workers tend to be more productive.

Low Saving and Investment

Insufficient saving reduces funds available for investment in capital and growth.

Vicious Cycle of Low Saving and Investment

Weak financial systems contribute to low saving and investment, which prevents growth and keeps incomes low.

Globalization

The process of countries becoming more open to foreign trade and investment.

Globalization and Economic Growth

The slides state that countries embracing globalization generally experienced higher growth rates than countries that remained closed.

Foreign Direct Investment (FDI)

A firm's purchase or construction of a facility in another country.

Foreign Portfolio Investment

The purchase of stocks or bonds issued in another country by an individual or firm.

How Can Foreign Investment Promote Growth?

It can replace insufficient domestic saving and provide capital, technology, and investment.

Growth Policy: Property Rights and Rule of Law

Strengthen property rights, independent courts, contract enforcement, and efforts against corruption.

Growth Policy: Health and Education

Improve health care and education to increase productivity and human capital.

Growth Policy: Technological Change

Encourage innovation, research, development, and foreign direct investment.

Growth Policy: Saving and Investment

Encourage saving and investment through secure property rights and incentives such as tax-advantaged saving or investment tax credits.

Brain Drain

The movement of highly educated and successful workers from developing countries to high-income countries.

How Can Better Health and Education Reduce Brain Drain?

Improved domestic opportunities and living conditions can encourage skilled workers to remain in their country.