L13._The_Classical_Model_of_Economic_Growth

Economic Growth: The Classical Model of Economic Growth

Presenter: Dr. Ahmad Hassan AhmadInstitution: School of Business & Economics, Loughborough UniversityContact Information: Email and phone number provided for consultations.

Reading List

Key Texts:

1. Economics, 11th edition by Begg, D., Vernasca, G., Fischer, S., Dornbusch, R.

2. Principles of Economics, 3rd European edition by McDowell, M., Thom, R., Pastine, I., Frank, R., Bernanke, B.

3. ONS UK economic updates available online.

Introduction to Economic Growth

Definition: Economic growth is characterized as the rate of change in real GDP per capita over an extended time frame, typically using fixed prices to foster accurate comparisons over time.

Comments on Definition

• Emphasis should be placed on growth based on real GDP to filter out inflation effects.

• The focus on per capita measurements provides insights into individual welfare levels and living standards.

• Economic growth assessments should span long durations, ideally between 7 to 10 years, to capture underlying trends.

• Ensuring consistency in measurements is crucial, ideally comparing data during similar phases of the business cycle (e.g., peak to peak or trough to trough).

UK’s Growth Experience

Economic growth has emerged as a relatively contemporary phenomenon in the UK, with growth rates remaining stagnant until the 18th century:

• 1700-1750: 0.6% annual growth.

• 1750-1776: 1.0% annual growth.

• 1776-1800: 2.8% annual growth.This period marks a significant transition from a feudal society to an economy focused on growth and industrialization.

English GDP Trends (1270 to 1913)

Visual representations correlate historical data reflecting GDP trends, which illustrate the evolution of economic capacity over centuries.

Classical Approach to Economic Growth

Originator: Adam Smith (1723 - 1790)The classical model initially faced criticisms and led to modifications proposed by theorists like Malthus, Ricardo, and Marx.

Adam Smith’s Pre-requisites for Growth

Smith outlined essential pre-conditions necessary for economic growth:

• Security of Property Rights: Legal protection of ownership is fundamental for investment.

• Control of Primogeniture: Regulations regarding inheritance to ensure land remains productive and does not fragment.

• State-provided Infrastructure: Essential facilities, such as roads and ports, are crucial for economic activities.

The Division of Labour

In The Wealth of Nations, Smith posits the following:

• Practice leads to increased dexterity among workers, thereby enhancing overall productivity.

• Dividing tasks minimizes the time lost in transitioning between different activities, improving efficiency.

• The use of machinery can significantly elevate productivity levels, further supporting economic growth.

The Growth Process

The division of labor acts as a catalyst for productivity and capital formation, resulting in:

• An increase in population spurred by rising wages, which subsequently boosts market demand.

• Theoretical coexistence of all social classes, though later theorists questioned this view.

Challenges to Smith’s View

Smith’s assumption that population growth directly correlates with output increases is challenged by real-world examples, such as the comparison between India and Sweden in terms of GDP per capita.

Malthus’s Theory of Population

Malthus warns against population growth outpacing food supply, emphasizing:

• Population expands geometrically while food availability increases arithmetically.

• Suggested checks on population growth to prevent food shortages include: moral restraints, social vices, and misery.

Malthus and Economic Growth

Malthus’s framework raises concerns regarding implications of income on subsistence levels among the population.

Economic Growth Dynamics

The average product (AP) per worker typically falls as employment rises, leading to:

• Temporary enhancements in living standards due to improved agricultural productivity.

• Malthus argues that such growth cannot sustainably uplift living conditions beyond certain thresholds.

David Ricardo’s Contribution

Ricardo developed a theory concerning rent and its association with economic growth, asserting:

• An optimistic outlook reliant on the repeal of the Corn Laws to foster growth.

Ricardo’s Economic Model

Ricardo's model illustrates how rents arise from land utilization, noting that:

• Rent is influenced by land fertility; the least fertile lands set the baseline for rental values.

• The escalating trend of using less optimal lands skews profits, indicating a near cessation of growth without legislative changes.

Economic Outputs and Rent

Visual tools are used to depict various economic factors such as land and output dynamics.

Income Distribution in Ricardo’s Model

Economic growth is affected by profits used for reinvestment, emphasizing the role of:

• Population growth and land policy in shaping profitability and the sustainability of growth.

Summary of Ricardo’s Theory

Ricardo contends that capital accumulation is directly linked to growth in population and food demand, noting:

• A scarcity of fertile land leads to rising prices and rental rates, which ultimately diminish profits.

Karl Marx’s Perspective

Marx’s views diverge from Ricardo, concentrating instead on exploitation inherent in capitalism and detailing:

• The plight of factory workers illustrated through historical contexts.

Living Conditions Under Capitalism

Detailed descriptions depict the poor living conditions experienced by workers during the industrial era, pointing to systemic inequalities.

Marx’s Economic Model

Marx argues that labor exploitation underpins capitalist profit, identifying unpaid labor as a key component.

Marx’s Growth Assumptions

Marx predicts that as mechanization rises, the organic composition of capital increases, leading to:

• Greater exploitation and overall unemployment among workers, coupled with dissatisfaction.

Industrial Concentration and Worker Conditions

An overview of competition impacts on capitalists illustrates the adverse conditions faced by the working class.

Evidence for Marx’s Model

Early struggles of the working class are documented, juxtaposed with post-1850 improvements in working conditions.

Classical Model Summary

The classical model highlights class divisions and their economic ramifications, asserting that:

• Investment of capitalist profits is crucial for driving growth amid persistent class conflicts.

Economic Growth Redistribution

An exploration of the redistributive effects stemming from classical economic growth theories on income across different social classes.