ECON Lecture 7.3: Determinants of Long-run Economic Growth and Global Case Studies

Distinguishing Between Extensive and Intensive Economic Growth

• Understanding the two separate concepts into which growth can be decomposed is essential for analyzing economic progress.

• Extensive Growth:

  • Definition: Extensive growth occurs by adding more labor and more capital (physical equipment) to the production process using the same quality and technology.

  • Impact: While this process increases total output (Total GDP), it does not necessarily increase the standard of living.

  • GDP Per Capita: Extensive growth can occur without any increase in GDP per capita. If population and production increase at the same rate, the individual standard of living remains constant.

  • Colonial Example: In the early colonial United States, farmers moved across the Appalachian Mountains into Ohio, Michigan, Tennessee, and elsewhere. They added more land to the country, but used the exact same technology (horse-drawn plows, wagons, and tools). If the population and land doubled but technology remained the same, total GDP doubled, but GDP per capita remained unchanged. The income level of a farmer in the new generation would be no higher than that of the previous generation.

• Intensive Growth:

  • Definition: Intensive growth involves adding better-quality labor and capital to the production process, rather than just more of the same.

  • Driver: Productivity is the core driver of intensive growth. Productivity implies that each individual worker accomplishes more in the same number of work hours compared to previous periods.

  • Result: Intensive growth always results in an increase in GDP per capita, meaning living standards are rising.

  • Agricultural Example: If farmers replace a horse-drawn plow with a powerful diesel tractor, each farmer can handle dramatically more land. The total amount of corn produced per farmer increases, causing GDP per capita to rise.

The Role of Physical and Human Capital in Development

• Physical Capital:

  • Physical capital refers to tangible equipment used in production. It is categorized into two main groups:

  • Infrastructure (Public Capital):

  • Often produced by the government in modern mixed economies.

  • Includes roads, bridges, interstate highways, dams, airports, and seaports.

  • Regional Differences: In Western Europe, the government often provides railroads and the electric grid. In the United States, the electric grid is primarily private (e.g., Georgia Power), and the freight rail system is almost entirely privately owned (excluding Amtrak for passengers). Seaports in the U.S., however, are typically government-owned.

  • Productivity Example: The U.S. Interstate Highway System significantly boosted trucker productivity. Driving on Cobb Parkway (Highway $41$) from Atlanta to Tampa once took multiple days due to traffic lights and stops. Today, a trucker can drive to Tampa and back in two days, increasing the number of loads delivered per worker-hour.

  • Business Capital (Private Capital):

  • Owned by private firms and individuals.

  • Examples include restaurant equipment for small businesses, trucks for logistics companies, or computers for major corporations like IBM.

• Human Capital:

  • Definition: This refers to the improvement of human skills and capabilities. People can "improve themselves" to increase their economic value.

  • Example: A high school graduate flipping hamburgers at McDonald's for $7.25$ per hour improves their human capital by earning an accounting degree. As a Certified Professional Accountant (CPA), they can perform jobs worth $30$ to $40$ per hour.

  • Mechanisms for Improvement:

  • Formal Education: K-$12$, colleges, and technical schools.

  • Informal Education: Apprenticeships and on-the-job training. Apprenticeships are vital for high-skill trades like plumbing or factory work.

  • International Comparison: Germany is famous for its highly successful apprenticeship programs that convert high school graduates into high-skill factory workers. The United States lacks a widespread apprenticeship culture outside of construction and a few factories.

Barriers to Global Economic Development

• Many countries suffer from a lack of development due to specific structural and institutional barriers:

• The Vicious Cycle of Poverty Hypothesis:

  • This argument suggests that poor countries remain poor because their low incomes force them to spend all resources on necessities, leaving nothing left for investment in new equipment.

  • Critique: While plausible, it is not an ultimate answer. The United States in $1865$ was poorer than many modern third-world nations but managed to escape poverty. Today, poor countries can tap into foreign savings. For example, a project in Botswana can raise capital via Wall Street in New York without requiring domestic savings.

• Capital Flight:

  • This occurs when local capitalists fear for the safety of their investments and move their money out of their home country to invest elsewhere.

  • Causes: Anti-capitalist regulations, fear of government seizures/confiscation, and lack of private property rights.

  • Personal Anecdote: The lecturer observed this in Miami, working for his father in construction. Wealthy individuals from Venezuela, Argentina, and Colombia bought and remodeled condos in Miami to protect their wealth from home-country governments threatening confiscation.

  • Impact: When capital leaves, productivity drops or stagnates as the country lacks the equipment needed for growth.

• Brain Drain:

  • The migration of highly skilled individuals (with high human capital) to advanced industrial nations.

  • Logic: An Indian computer science graduate can earn significantly more in Silicon Valley working for Apple than at home because the U.S. has a higher density of versatile tech companies.

  • Result: Advanced nations benefit from this influx, while poor countries lose their most productive workers.

• Poor Legal, Political, and Economic Institutions:

  • This is considered the most important factor in underdevelopment.

  • If legal systems do not protect property rights, business people will refuse to start companies or will "milk" their existing businesses and move profits abroad (Capital Flight) to places like London, Switzerland, or Miami.

Historical Case Studies of Economic Divergence

• Comparison 1: Germany, Japan, and Argentina ($1900$ - $2010$):

  • In $1900$, Argentina was slightly ahead of Germany in GDP per capita; Japan was significantly poorer, with about half their income.

  • By $2007$, Argentina reached the middle-income level of approximately $10,000$ per capita.

  • Germany and Japan reached the wealthy status of over $20,000$ per capita.

  • Note on WWII: Both Germany and Japan were decimated between $1941$ and $1944$. Germany was invaded by Russians from the East and Americans/British from the West. Despite starting from almost zero in $1944$, they surpassed Argentina by a wide margin.

  • Reason: Argentina's anti-capitalist tradition (price controls, import/export controls) stunted its growth.

• Comparison 2: Cuba, Puerto Rico, and Panama ($1950$ - $2008$):

  • In $1950$, all three shared similar cultures, languages, and roughly tied income levels. Havana, Cuba, was a cultural and economic hub.

  • Post-$1958$ Revolution: Under Fidel Castro, Cuba's growth stagnated.

  • The "$1990$ Effect": After the Berlin Wall fell and the Soviet Union stopped subsidizing Cuban sugar with artificially high prices, the Cuban economy collapsed. By $1993$, Cuba's income per person was lower than in $1950$.

  • Current Status: The average Puerto Rican produces in the $15,000$ range, while the average Cuban produces below $4,000$.

• Comparison 3: North Korea and South Korea ($1953$ - $2008$):

  • Linguistically and culturally identical people separated by war.

  • Until the $1970s$, there was little difference in income levels.

  • Since the $1970s$, South Korea experienced one of the most dramatic economic explosions in world history, moving from under $3,000$ to over $20,000$ GDP per capita.

  • South Korea's success is tied to global capitalist brands like Samsung and Kia. North Korea, under a communist system, remains stagnant at $1950s$ income levels.