Economic Growth & Productivity

Economic Growth & Productivity

Outline

• Introduction

• Economic Growth & Public Policy

• Developed Country Growth Opportunities & Challenges

• Facing Developing Countries

• Tradeoffs in Economic Growth

Introduction

• The Classical Model:

  • Describes a static economy at long-run equilibrium with full employment.

  • Factors:

  • Factor endowments are fixed.

  • Technology is fixed.

  • Dynamic Nature of Economies: Real economies change and grow over time.

  • This lecture adapts the classical model to consider:

  • Effects of changes in factor endowments.

  • Effects of technology policies to promote economic growth.

Real GDP per Capita

• Global Variation: Real GDP per capita varies widely among countries.

• Indicators of Well-Being: Real GDP per capita is closely linked to various indicators such as:

  • Health

  • Education

  • Surveys of life satisfaction

Real GDP per Capita 2021 (US Dollars)

• Source: The Conference Board, Total Economy Database

  • Graph Data:

  • Time series from 1950 to 2022 for various countries: US, UK, Japan, South Korea, Ghana, Uganda, Mali, DR-Congo.

  • Significant differences in GDP per capita are evident.

The Mathematics of Growth

• Notation:

  • Let:

  • $Y_0$ = current year real GDP per capita

  • $Y_n$ = real GDP per capita in n years

  • $g$ = the growth in real GDP per capita

  • Future Values:

  • $Y<em>1 = Y</em>0 imes (1 + g)$

  • $Y<em>2 = Y</em>1 imes (1 + g) = Y_0 imes (1 + g)^2$

  • $Y<em>n = Y</em>0 imes (1 + g)^n$

Growth Rates and Real GDP Per Capita

• Growth Rate Data:

  • Breakdown of growth rates at different annual growth rates (2%, 4%, 6%, 8%) over a time period:

  • Years 0 to 100 presented in a table showing cumulative values based on growth.

Growth Equations

• Real GDP:

  • $ext{Real GDP} = ext{Labor Productivity} imes ext{Average Hours} imes ext{EPR} imes ext{Population}$

• Real GDP per Capita:

  • $ext{Real GDP per capita} = ext{Labor Productivity} imes ext{Average Hours} imes ext{EPR}$

Factors in the Growth of US Real GDP per Capita

• Annual Percentage Growth Analysis:

  • Different contributing factors from 1951 to 2015:

  • Each period's EPR contributions ranged from 0.1% to -0.6%.

  • Average hours contributed negatively or neutrally in certain periods.

  • Labor productivity contributed significantly in various periods, highest being 2.6% between 1951 to 1973.

  • Growth Rate Equation:

  • ext{%ΔReal GDP per capita} ext{ ≈ %ΔLabor Productivity + %ΔAverage Hours + %ΔEPR}

Labour Force Participation Rate (2021)

• Percentage Participation:

  • Table showing participation rates for various countries and regions, including OECD averages and individual country statistics.

Growth in the Employment-Population Ratio (EPR)

• Government Policy Impact:

  • Policies that can increase EPR:

  • Adjustments in income taxation.

  • Generosity of social safety nets.

  • Support for child and elder care.

  • Support for retraining and relocation.

  • Outcome: Improvements in EPR can influence GDP per capita positively.

Limits on Increasing EPR

• Increasing EPR contributes to improving GDP per capita but does not guarantee sustained economic growth.

• Sustainability Issue:

  • EPR must increase yearly to maintain growth, yet is constrained by external factors.

Increasing Labor Productivity

• Path to Sustained Growth:

  • Long-term growth is primarily driven through increased labor productivity.

• Key Influences on Labor Productivity:

  • Amount of physical capital per worker.

  • Amount of human capital per worker.

  • Technology available to workers.

  • Analysis to follow on each of these components.

Labor Productivity Growth: Physical Capital

• Definition:

  • Physical Capital ($K$) refers to equipment and structures used in production.

• Capital per Worker:

  • $rac{K}{L} = ext{capital per worker}$

  • Higher capital per worker leads to increased labor productivity and real GDP per capita.

Labor Productivity Growth: Investment & Capital Stock

• Roles of Investment and Depreciation:

  • Investment increases capital stock, whereas depreciation decreases it.

  • Equation:

  • $ext{Δcapital stock} = ext{investment} - ext{depreciation}$

Government Policy & Capital Stock

• Private Investment:

  • Impacts from corporate income taxes, investment tax credits, and policies aimed at increasing private savings.

• Alternative Tax Policy:

• Shifts away from taxing savings towards consumption taxes for increased investment.

The Government Budget

• Government Budget Deficit:

  • Deficits can impact real interest rates (r) and private investment (I).

• Cuts to Government Spending:

  • Effects vary based on cuts; some cuts may reduce public capital while increasing private investment.

Limits on Increasing Physical Capital

• Diminishing Returns:

  • Increasing physical capital has diminishing returns due to fixed labor.

  • Maximization occurs when all output ($Y$) covers depreciation.

Human Capital

• Definition:

  • Human capital ($H$) represents knowledge and skills acquired through education, training, and experience.

• Capital per Worker:

  • $rac{H}{L} = ext{human capital per worker}$

  • Increased human capital contributes positively to labor productivity and real GDP per capita.

Government Policy & Human Capital

• Encouraging Investment:

  • Government actions can lower educational costs and provide subsidies for higher education and training.

• Interest Rates Impact:

  • Lower real interest rates also facilitate investment in human capital.

Limits on Increasing Human Capital

• Challenges noted in the costs associated with formal education and opportunity costs.

• Tradability of Human Capital:

  • Human capital depreciates over time as workers retire or their skills become obsolete.

Labor Productivity Growth: Technological Change

• Definition and Importance:

  • Technological change refers to the use of new inputs, outputs, or production methods.

  • Historically significant for growing GDP per capita.

Labor Productivity Growth: Technological Innovation

• Aspects of Technological Change:

  • Not limited to machines; includes organizational and institutional advances that enhance productivity (e.g., assembly lines, electrical grids, the Internet).

Growth in Developed Countries

• Contributors to Growth:

  • Growth can result from increased physical/human capital or improved technology.

  • Developed countries often possess existing high levels of both.

  • Innovation Dependence: Growth heavily reliant on discovery-based growth (technological changes from new ideas).

Research and Development (R&D)

• Necessity for Growth:

• Growth hinges on the extent and effectiveness of R&D.

• Government Roles:

  • Policies facilitating investment in physical capital will indirectly stimulate R&D.

  • Support for basic research in public institutions and universities is essential.

Institutional Support for Innovation

• Protection of Intellectual Property:

  • Patent law grants exclusive rights for a fixed period (usually 20 years).

  • Importance of clearly defined patent rights to encourage innovation and protect from infringement.

Opportunities Facing Developing Countries

• Catch-Up Growth:

  • Potential for rapid growth, much faster than historically developed nations.

  • Conditions Favoring Growth:

  • High marginal productivity of capital, low human capital, and inferior technology available.

Challenges Facing Developing Countries

• Poverty Trap:

  • Many developing countries struggle to escape extreme poverty due to:

  • Poor institutions.

  • High population growth hindering investments.

Poverty and Investment

• Investment Difficulties:

  • Extreme poverty limits savings and investment opportunities as individuals prioritize consumption over saving.

  • Lack of investments hampers technological adoption necessary for improvement.

Foreign Investment & Foreign Aid

• Foreign Involvement:

  • Foreign investment can elevate capital per worker and bring technology transfers.

  • Government borrowing abroad can enhance local infrastructure through foreign aid.

• Types of Foreign Investment:

  • Foreign Direct Investment (FDI): capital investment owned by a foreign entity.

  • Foreign Portfolio Investment: domestic operations financed by foreign capital.

Political Stability & Property Rights

• Investment Challenges:

  • Many developing nations lack attraction for investment due to unstable political climates and weak property protection.

  • Essential for markets to function: respect for property rights must be upheld.

Case Study: Zimbabwe vs. Botswana

• Comparison of Governance:

  • Botswana: Strong protections for property rights, independent judiciary, transparent government.

  • Zimbabwe: Property confiscations, political violence, corruption, and economic instability.

• Economic Performance:

  • Botswana has shown significant growth (9% from 1966-1999), while Zimbabwe has experienced declines.

Population Growth & Capital per Worker

• Population Growth Effects:

  • High population growth can increase labor (L) but reduce capital per worker (K/L).

  • Lower effective labor productivity results from this dynamic effect.

Dependency Ratio due to Population Growth

• Impact on EPR:

  • Rapid population growth often leads to a higher dependency ratio, complicating savings and investment efforts.

Population Pyramids

• Visual Representation:

  • Population pyramids display the demographic distribution across age and gender for countries like Nigeria and the USA.

Economic Growth Tradeoffs

• Current vs Future Consumption:

  • An increase in physical capital, human capital, or technology often requires higher savings, resulting in reduced current consumption.

• Social Implications:

  • Altering social safety nets for growth could negatively impact vulnerable populations.

  • Additionally, growth could be achieved at the expense of environmental goals, posing further ethical dilemmas.