ECON 104 Ch. 12
Production and Growth: Chapter Summary
12-1 Economic Growth around the World
Economic Growth Defined: The sustained expansion of production possibilities, measured as the increase in real Gross Domestic Product (GDP) over a given period.
Rapid and sustained economic growth can transform poor nations into rich ones, as seen in South Korea and other Asian economies.
Slow or absent growth can lead to severe poverty, exemplified by Somalia and Zambia.
Variations in the Standard of Living:
Across Countries: Living standards differ significantly. Average income in rich countries (e.g., U.S., Japan, Germany) can be about ten times that of poor countries (e.g., Nigeria, Nicaragua).
These differences manifest in varied quality of life aspects like nutrition, housing, healthcare, and life expectancy.
Within a Country Over Time: In the U.S., real GDP per person has grown at approximately 2\% per year over the past 100 years.
Dynamic Nature of Country Rankings:
The income ranking of countries changes substantially over time. Poor countries are not condemned to perpetual poverty; Japan, with low incomes in 1860, now has high incomes.
Rich countries cannot take their status for granted, as they can be overtaken by faster-growing, poorer nations.
Growth Experiences (Real GDP per person in 2020 dollars):
China (1900–2020): From 834 to 17,312, growth rate 2.56\% per year.
Japan (1890–2020): From 1,751 to 42,197, growth rate 2.48\% per year.
Brazil (1900–2020): From 907 to 14,836, growth rate 2.36\% per year.
Mexico (1900–2020): From 1,350 to 18,833, growth rate 2.22\% per year.
Indonesia (1900–2020): From 1,038 to 12,074, growth rate 2.07\% per year.
Germany (1870–2020): From 2,544 to 53,694, growth rate 2.05\% per year.
Canada (1870–2020): From 2,766 to 48,073, growth rate 1.92\% per year.
India (1900–2020): From 786 to 6,454, growth rate 1.77\% per year.
United States (1870–2020): From 4,668 to 63,544, growth rate 1.76\% per year.
Argentina (1900–2020): From 2,671 to 20,768, growth rate 1.72\% per year.
Bangladesh (1900–2020): From 726 to 5,083, growth rate 1.64\% per year.
Pakistan (1900–2020): From 859 to 4,877, growth rate 1.46\% per year.
United Kingdom (1870–2020): From 5,601 to 44,916, growth rate 1.40\% per year.
Key Questions for Economic Growth:
Why do some countries accumulate more wealth than others?
What causes some countries to achieve rapid growth while others remain trapped in poverty?
What policy interventions can effectively boost growth rates and improve long-run living standards?
12-2 Productivity: Its Role and Determinants
Productivity Defined: The quantity of goods and services produced from each unit of labor. It is the key determinant of living standards.
When a nation's workers are highly productive, the real GDP is large, leading to high incomes.
Mathematically, Productivity (Y/L), where Y = real GDP (quantity of output produced) and L = quantity of labor.
Importance of Productivity:
Growth in productivity is the fundamental determinant of growth in living standards.
Rapid productivity growth directly translates to rapid improvements in living standards.
A nation's income fundamentally equates to its output; thus, a high standard of living requires the ability to produce a large quantity of goods and services.
Determinants of Productivity:
Physical Capital (K/L):
Definition: The stock of equipment and structures utilized to produce goods and services.
Impact: Productivity is higher when the average worker has more physical capital (machines, tools, etc.). An increase in physical capital per worker (K/L) directly causes an increase in output per worker (Y/L).
Human Capital (H/L):
Definition: The knowledge and skills acquired by workers through education, training, and experience.
Impact: Productivity is higher when the average worker possesses more human capital (education, skills). An increase in human capital per worker (H/L) directly causes an increase in output per worker (Y/L).
Natural Resources (N/L):
Definition: The inputs into the production of goods and services provided by nature, such as land, rivers, and mineral deposits.
Impact: All else being equal, a greater abundance of natural resources per worker (N/L) allows a country to produce more output (Y). An increase in natural resources per worker (N/L) causes an increase in output per worker (Y/L).
Technological Knowledge (A):
Definition: Society's collective understanding of the optimal methods for producing goods and services.
Characteristics: It can be common knowledge (e.g., after initial use, it becomes widely known).
Impact: Any advancement in knowledge that boosts productivity allows society to generate more output from its existing resources. Examples include faster computers, higher-definition TVs, smaller cell phones, or production innovations like Henry Ford's assembly line.
12-3 Economic Growth and Public Policy
Policy Focus: Since a society's standard of living hinges on its productivity, and productivity relies on the four determinants (K/L, H/L, N/L, and technological knowledge), policymakers aim to raise these factors.
Key Public Policy Areas Affecting Long-Run Growth:
Saving and Investment:
Mechanism: To enhance future productivity, societies must encourage saving and investment.
Trade-off: This involves sacrificing some current consumption to allocate more resources to the production of capital goods, thereby increasing future consumption.
Impact: A higher savings rate leads to more resources available for capital creation, increasing the capital stock.
Diminishing Returns and the Catch-Up Effect:
Diminishing Returns Definition: The principle that the benefit derived from an additional unit of an input declines as the quantity of that input increases.
Implications for Saving: In the long run, a higher saving rate leads to a higher level of productivity and income. However, the subsequent faster growth from this higher saving is temporarydue to diminishing returns to capital.
Production Function Illustration: As capital per worker (K/L) increases, the extra output (Y/L) gained from an additional unit of capital diminishes, making the production function curve flatter.
Catch-Up Effect Definition: The phenomenon where countries that begin with lower initial levels of income and capital per person tend to grow more rapidly than countries that start off rich.
Explanation: Capital accumulation is subject to diminishing returns. Poor countries have less capital, so small investments yield substantial increases in worker productivity, leading to faster growth. Rich countries, with abundant capital, experience smaller gains from additional capital investment.
Example: From 1960–1990, the U.S. and South Korea invested a similar share of GDP. However, Korea's growth exceeded 6\% while the U.S. grew at 2\% due to Korea's much lower initial capital per worker, allowing it to benefit more from the catch-up effect.
Investment from Abroad:
Sources: Domestic savings (private and public) and investment from foreign sources both increase a country's capital stock.
Types:
Foreign Direct Investment (FDI): Capital investment owned and operated by a foreign entity.
Foreign Portfolio Investment: Investment financed with foreign money but managed by domestic residents.
Benefits: Foreign investment contributes to the host economy's capital stock, leading to higher productivity and wages. It also facilitates the transfer of state-of-the-art technologies, particularly beneficial for poor countries struggling to generate sufficient domestic saving.
International Institutions: Organizations like the World Bank and the International Monetary Fund (IMF) were established to promote economic prosperity by encouraging capital flow to developing countries through loans funded by advanced nations.
Education:
Human Capital Investment: Education is a crucial investment in human capital.
Returns: In the U.S., each year of schooling is associated with a 10\% increase in a worker's wage.
Opportunity Cost: The wages forgone by students during their education.
Positive Externalities: Education provides broad societal benefits beyond the individual, justifying public education subsidies.
Challenge for Poor Countries: The emigration of many of their most educated workers to rich countries where human capital can earn a higher return, often referred to as "brain drain." This reduces the stock of human capital available for domestic economic development.