Chapter 9: Long-Run Economic Growth

LONG-RUN ECONOMIC GROWTH IN MACROECONOMICS

WHAT YOU WILL LEARN IN THIS CHAPTER

• Long-run economic growth definitions and measurements:

  • Long-run economic growth is measured as the increase in real GDP per capita.

  • Importance of understanding how real GDP per capita has changed over time in different countries.

• Role of productivity:

  • Productivity is key to long-run economic growth.

  • Productivity is driven by three primary factors: physical capital, human capital, and technological progress.

• Growth rate differences among countries:

  • Discussion on why long-run growth rates differ significantly across countries.

• Regional growth variations:

  • Analysis of growth variations among important global regions.

  • Examination of the convergence hypothesis applicable to economically advanced countries.

• Challenges to sustainable growth:

  • Examines how scarcity of natural resources and environmental degradation pose challenges to sustainable long-run economic growth.

THE SMOG OF PROSPERITY

• Air quality and economic growth:

  • Notable poor air quality in cities like Delhi and Beijing is a consequence (by-product) of remarkable economic growth.

COMPARING ECONOMIES ACROSS TIME AND SPACE

Key Statistics: Real GDP Per Capita

• Definition of Real GDP Per Capita:

  • Real GDP per capita is calculated as real GDP divided by the population.

  • Focus on GDP as it measures income earned within an economy over a year.

  • Use of real GDP to separate changes in the quantity of goods and services from price fluctuations.

  • Real GDP per capita helps isolate population effect changes.

• Historical growth comparison:

  • Growth rates since 1980: India and China experienced much higher growth rates than Canada and the USA.

  • Comparisons of standards of living across timelines:

  • Canada’s standard of living in 1900 matched by China in 1999 and India in 2011.

LEARN BY DOING: PRACTICE QUESTION 1

• Scenario:

  • Real GDP for Macronesia in 2010 is $200 million with a population of 100,000.

  • Population grows to 105,000 in 2011 while GDP increases by 5%.

• Question:

  • Real GDP per capita in 2011 must be: (correct answer: c) stayed constant)

CANADIAN REAL GDP PER CAPITA

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• Growth over time:

  • Canadian economy produced almost ten times more per person in 2018 compared to 1900.

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Table 9-1: Canadian Real GDP per Capita Across Years:

• Income distribution:

  • Countries in Europe and North America have high incomes.

  • A quarter of the global population lives in countries with a lower standard of living than Canada had a century ago.

GROWTH RATES

• Canada's GDP growth:

  • Canada's real GDP per capita grew nearly tenfold since 1900 due to a gradual process of few percent growth per year.

• Rule of 70:

  • Rule of 70 provides an estimate on how long it takes for a variable to double based on its growth rate.

    

  • Example: If real GDP per capita grows at 3.5%, doubling time is computed as:

  • For 3.5% growth: (70 / 3.5 = 20 ext{ years}).

  • Notably, small improvements compound rapidly over time.

LEARN BY DOING: PRACTICE QUESTION 2

• Scenario:

  • India's GDP per capita is $3,000 growing at 5% per year targeting the level of $24,000 (Italy's GDP per capita).

• Question:

  • How many years to reach target using the Rule of 70? (correct answer: a) 42 years)

COMPARING RECENT GROWTH RATES

• Visual representation:

  • Figure 9-3 illustrates contemporary growth rates across different economies.

THE SOURCES OF LONG-RUN GROWTH

• Rising productivity:

  • Long-run economic growth profoundly depends on rising productivity, which needs continued output increases from the workforce. (Neoclassical idea)

• Definition of Labour Productivity:

  • Labour productivity is defined as output per worker.

  • Productivity is the real GDP divided by the number of employed persons.

EXPLAINING GROWTH IN PRODUCTIVITY

• Increased productivity factors:

  • Modern workers exhibit increased physical capital, higher education levels, and leverage a century of technological advancement.

• Three primary sources of productivity growth:

  1. Increases in Physical Capital:

  • Definition: Human-made resources such as buildings and machines.

  1. Increase in Human Capital:

  • Definition: Improvements in labor due to education and knowledge of the workforce.

  1. Technological Progress:

  • Definition: Advances in technical means of production of goods and services.

ACCOUNTING FOR GROWTH: AGGREGATE AND PER WORKER PRODUCTION FUNCTIONS (1 of 5)

• Aggregate Production Function Model:

  • Equation: (Y = A × F(K, L, H))

  • Where:

    • Y = real output (GDP)

    • K = physical capital

    • L = labor

    • H = human capital

    • A = total factor productivity (estimate of technological level)

  • Example for GDP per worker:

  • ( ext{GDP per worker} = A × ( ext{Physical capital per worker})^{1/3} × ( ext{Human capital per worker})^{2/3})

ACCOUNTING FOR GROWTH: AGGREGATE AND PER WORKER PRODUCTION FUNCTIONS (2 of 5)

• Diminishing Returns to Physical Capital:

  • Diminishing returns manifest when maintaining constant levels of human capital per worker and technology, each added unit of physical capital adds less productivity.

  • Example: A second computer increases productivity but less significantly than the first.

ACCOUNTING FOR GROWTH: AGGREGATE AND PER WORKER PRODUCTION FUNCTIONS (3 of 5)

• Continued diminishing returns:

  • These effects occur under controlled variables of technology and human capital.

  • Increases in human capital or improvements in technology can offset diminishing returns, enhancing productivity.

ACCOUNTING FOR GROWTH: AGGREGATE AND PER WORKER PRODUCTION FUNCTIONS (4 of 5)

• Growth Accounting:

  • Growth accounting estimates contributions of fundamental factors in the aggregate production function.

  • Total factor productivity indicates possible output with available input quantities.

  • When total factor productivity increases, the economy can produce more output with the same quantity of physical capital, human capital, and labour.

ACCOUNTING FOR GROWTH: AGGREGATE AND PER WORKER PRODUCTION FUNCTIONS (5 of 5)

• Importance of Total Factor Productivity:

  • Key component in economic growth.

  • Technological advancements fuel increases in total factor productivity.

  • From 1961 to 2021, Canadian labor productivity rose at a rate of 1.8% per year:

  • 78% attributed to increases in physical and human capital per worker.

  • Remaining attributed to increases in total factor productivity through technological progress.

WHAT ABOUT NATURAL RESOURCES?

• Natural resource impact:

  • Though natural resources influence productivity, they are not as important than human or physical capital in contemporary economies.

  • Example: Japan has low resources but high GDP per capita; Nigeria, rich in resources, has low GDP per capita.

ECONOMICS IN ACTION: THE RISE, FALL, AND RETURN OF THE PRODUCTIVITY PARADOX

• Technological Change vs. Economic Payoffs:

  • Economic benefits of revolutionary technological advancements are challenging to discern immediately.

WHY GROWTH RATES DIFFER (1 of 4)

• Characteristics of rapidly growing economies:

  1. High rates of savings and investment spending.

  2. Focus on education improvements.

  3. Emphasis on research and development (R&D).

WHY GROWTH RATES DIFFER (2 of 4)

• Savings and investment spending:

  • As of 2022, investment spending accounted for 42% of China’s GDP compared to 23.3% in Canada.

  • High investment spending is closely linked to high domestic savings levels.

  • Countries that have high investment spending do so because they have high domestic savings.

WHY GROWTH RATES DIFFER (3 of 4)

• Education improvements:

  • China’s rapid growth is significantly aided by human capital enhancement.

WHY GROWTH RATES DIFFER (4 of 4)

• Research and Development (R&D):

  • Definition: Investment in creating new technologies and their practical application.

  • Historical context: U.S. businesses pioneered R&D with the establishment of Thomas Edison's first industrial research laboratory in 1875.

THE ROLE OF GOVERNMENT IN PROMOTING ECONOMIC GROWTH

• Government influence on growth rates:

  • Policies that stimulate economic growth include:

  1. Infrastructure subsidies:

  • Investments in physical infrastructure underpin economic activity.

  • China invests more in infrastructure than all of Western Europe and North America combined.

  2. Government subsidies to education:

  • Over 90% of primary and secondary education funding in Canada originates from government sources.

  • Comparative literacy trends show China’s growth in education surpassing Argentina not due to wealth but prioritization of education.

3. Research and development subsidies:

• Governments actively conduct R&D and provide businesses with financial incentives for their R&D expenditures.

• 4. Maintaining a well-functioning financial system:

• Proper functioning of financial systems is essential; distrust leads to capital being hoarded rather than invested.

• Legal and regulatory frameworks:

  5. Protection of property rights:

  • Property rights are legal rights allowing owners to manage and dispose of their valuable assets.

  • Intellectual property rights protect innovators and reward them for their contributions.

  • Patents act as temporary monopolies, safeguarding innovators’ rights to their inventions.

THE ROLE OF GOVERNMENT IN PROMOTING ECONOMIC GROWTH (4 of 4)

• Political environment considerations:

  6. Political stability and governance:

  • Secure investment landscapes are possible due to good governance, legal frameworks, and institutional stability.

  • The growth of Canada owes itself to these sound institutional infrastructures.

EAST ASIA’S MIRACLE (1 of 2)

• Rapid economic growth timeline:

  • Remarkably, South Korea achieved significant growth over just 35 years, requiring centuries elsewhere.

  • Since 1975, East Asian countries have increased real GDP per capita by 6% annually, surpassing North America's historical growth rates.

• Mechanisms of success in East Asian economies:

  • High savings rates promote physical capital accumulation.

  • Strong basic education systems enhance human capital.

  • Substantial advancements in technology.

EAST ASIA’S MIRACLE (2 of 2)

• Catch-up effect in growth:

  • Countries with lower GDP per capita can achieve faster growth rates by adopting established technologies.

  • Convergence hypothesis:

  • Countries with lower GDP per capita tend to have higher growth rates over time, thereby narrowing income disparities.

  • Caveat: Low GDP per capita alone does not guarantee rapid growth, as shown by examples from Latin America and Africa.

LATIN AMERICA’S DISAPPOINTMENT

• Challenges facing Latin American economies:

  • Argentina and similar nations struggle due to:

  • Irresponsible governmental policies causing erosions in savings through inflation.

  • Insufficient emphasis on education systems.

  • Political instability hampering economic resilience.

AFRICA’S TROUBLES AND PROMISE

• Hindrances to African growth:

  • Major issues include:

  • Government corruption.

  • Persistent civil wars and political instability.

  • Geographical challenges.

  • Discussion on the interrelation of poverty and political instability.

  • Positive outlook: post-2011 growth rates have improved in many sub-Saharan African nations.

LEFT BEHIND BY GROWTH?

• Economic growth versus income distribution:

  • While rising real GDP per capita typically raises real incomes, disparities in growth benefits can occur, often favoring the highest-income 1%.

  • Dual considerations:

  1. Economic growth does improve the living standards of the majority.

  2. Growth contributes to the emergence of a global middle class, elevating previously impoverished individuals in countries like China.

LEARN BY DOING: PRACTICE QUESTION 3

• Question posed:

  • Economic growth can be especially fast: (correct answer: d) (a), (b), and (c))

IS WORLD GROWTH SUSTAINABLE?

• Definition of sustainable growth:

  • Sustainable long-run economic growth continues amidst limited natural resource supplies while minimizing environmental impact.

NATURAL RESOURCES AND GROWTH, REVISITED

• Neo-Malthusian theories:

  • Critics argue economic growth will be severely hindered by resource scarcity; however, modern economies are adept at managing scarcity.

  • Scarcity leads to elevated prices, which incentivize conservation and innovation, illustrated by consumer responses to oil price spikes in the 1970s.

ECONOMIC GROWTH AND THE ENVIRONMENT (1 of 2)

• Environmental impacts:

  • Economic growth tends to adversely affect the environment, leading to issues such as:

  • Pollution.

  • Loss of wildlife habitats.

  • Species extinction.

  • Reductions in biodiversity.

  • Distinction between local and global environmental issues, with climate change presenting unique challenges.

ECONOMIC GROWTH AND THE ENVIRONMENT (2 of 2)

• Climate change implications:

  • Definition: Climate change refers to alterations in Earth’s climate instigated by human activities.

  • Potential costs of unmitigated climate change projected at 20% of global GDP by 2100, with a disproportionate burden on poorer nations.

  • Challenge in solving climate change lies in the necessity for collective international cooperation.

  • Net-Zero Greenhouse Gas Emissions Act of 2021 (Canada):

  • Establishes a framework aimed at achieving net-zero greenhouse gas emissions by 2050.