10 - Economic Growth

Economic Growth Facts

Growth Since 1 Million B.C

  • started as hunter-gatherers, farming and agriculture helped form communities

  • most people lived in poverty, starved

  • GDP was very slow to rise

  • agricultural techniques improved with crop rotation, high-yielding crops, new equipment, and better distribution due to transportation infrastructure leading to less hunger with less farmers

  • industrial revolution created lots of economic growth, fewer resources were needed to grow food so resources were used for other activities

    • inventions like the steam engine, telephone, and lightbulb so machines could substitute for human or animal labour

    • people could produce more, lots of factory work, production output increased rapidly

    • beginning of the rise in income and living standards

    • took around 600 yrs original for global GDP per person to double but it more than doubled in the 18th century and early 19th

  • economic growth means people produce and consume more leading to rising living standards and longer life

  • some countries didn’t see the rise in life expectancy as the agricultural and industrial revolutions didn’t cause growth everywhere

Growth over the Past 2 Centuries

  • countries with faster growing GDP concentrated in Western Europe and Northern Europe causing a difference in places where GDP grew slower like Africa

  • recently there has been more rapid growth in developing countries like India and China (income) compared to Canada and the US, decreasing inequality

The Ingredients of Economic Growth

The Production Function

  • production function describes the methods by which inputs are transformed into outputs and determines the total production possible

  • describes how different mixture of inputs can be combined to produce variable output

  • a company’s production function describes the total quantity of output the business can produce depending on quantities of inputs

  • the aggregate production relates to total output or GDP to the quantity of inputs employed

    • key variables are Labour (L), human capital or skills brought to job (H), physical capital like tools, machines and structures (K)

    • aggregate doesn’t include a role for intermediate inputs

  • the function describes how output varies with inputs

    • Y = f(L, H, K)

    • a company will produce more output by employing more labour, if workers become more skilled or if it increases physical capital

    • reflect production techniques known at a specific point in time, more efficient techniques will shift function

Labour and Total Hrs Worked

  • total quantity of labour input is the sum of all hours worked across the whole economy

    • reflect the size of the population, fraction of working age, share of working age who choose to work and number of hours

  • increase in population boosts total GDP but not per person

    • seen in countries with more births, less death, more immigration

    • larger population might not lead to better living standards since DP is shared by more people

  • dependency ratio measures the number of people too young (under 18) or too old (65+) to work per 100 people of working age

    • baby boomers approaching retirement and dependant will slow down economic growth

  • shift of women into the job market increased employment and economic growth

  • shorter work weeks reduce GDP but might raise well being, GDP doesn’t consider leisure

Human Capital

  • labour productivity is how much each worker produces per hour which depends on human capital

  • literacy is a key tool in further learning and is required for the economy to grow to read instructions, communicate, to jobs

  • secondary and postsecondary education promotes greater productivity, higher incomes

Capital Accumulation

  • capital stock is the total quantity of physical capital and it includes all equipment and structures used in the production of g

    • privately owned tools, machines, factories, government infrastructure like roads, electricity

  • viewed as a complement to labour so workers can produce with the correct tools

  • quantity of capital per work determines labour productivity

  • companies grow capital stock by investing in new equipment and structures and investment comes from saved resources (not consumed)

    • the savings rate is critical in determining of investment and determines the amount of capital workers have

Technological Progress

  • technological progress is finding new methods for using existing resources, creating more valuable output from available input

  • involves new production techniques from scientific discoveries, better wats of doing things, a new way to combine inputs

  • computers aren’t the progress but the capital that embodies the progress like the sand it is made of

Analytics of Economic Growth

Production Function

  • constant returns to scale implies that by increasing all inputs in the function by some proportion will make outputs rise by the same proportion

    • doubling inputs doubles outputs

    • if CA population, capital stock and investment in education rise in proportion so human capital doesn’t change, GDP per person will stay the same

  • diminishing returns to capital where if only capital input is increased while others are held constant, the increase will slowly yield smaller outputs

    • fixed number f workers and no changes in technology means an increase in capital will yield smaller boosts with time, each investment less helpful than the previous

    • when workers don’t have lots of capital, adding more unit of capital per person leads to gains in output but this decreases when people have lots of capital

  • diminishing returns means additional capital investments won’t boost output in rich countries with capital but do help in gains for poor countries who have little to start

    • poor countries investing in physical capital will result in rapid output growth

    • this type of rapid growth is catch-up growth and it raises the possibility that if poor countries make similar investments to the rich, the gap between both will narrow

Capital Accumulation and the Solow Model

  • capital stock will grow as long as investment outpaces depreciation

    • a country’s capital investment evolves over time due to investment and depreciation

    • investment in new equipment boosts capital stock and the ability to produce output but each year, a proportion is destroyed by depreciation

    • capital will accumulate as long as investment exceeds depreciation

    • according to the production function, as long as capital per person grows, output per person will grow and living standards will rise

    • the economy will grow as long as investment exceeds depreciation

  • capital per worker will eventually stop growing

    • rising depreciation as more capital will fail as you increase investments each year so you need larger amounts of investments to replace lost capital

    • diminishing returns will cause future capital investments to generate smaller effects on output

    • if a portion of the output is used to increase investments, your investment amount will start to decrease more with time

    • at some point, the amount of new investment won’t outpace depreciation so capital will stop growing

  • capital accumulation can’t sustain long term economic growth

    • successive cycles of increased capital will lead to smaller boosts in output and then investments while depreciation will continuously rise

    • the process will stall because the economy grows to a point where new investments in capital will offset depreciation or the steady rate

    • when capital stops growing, output will too

Technological Progress

  • technological progress shifts the production function, increasing the output generated from inputs (upward boost)

  • economy with a given amount of capital per worker can produce more output per person than before

  • progress books the extra output each extra machine produces so investments are more productive and valuable, leading to a higher and steady state of capital

  • since the new production curve is steeper, progress will increase the effect investment will have on output per person

  • progress leads to more output from existing inputs and spurs capital accumulation, raising level of inputs

  • key to sustained growth is sustained technological progress

  • progress is driven by how quickly new ideas are created and the resources devoted to generating new ideas

    • workers produce g/s or ideas so the number of workers focused on new ideas rises from population growth or allocating resources to producing ideas

    • tradeoff where if everyone produced g/s, the economy produces more g/s in the short run while in the long run there would be no economic growth due to no technological progress

    • if enough resources are devoted to research and development, there will be a steady stream of ideas

  • when people were in a battle to survive, there were no resources to generate ideas explaining lack of technological progress

  • the more the economy produces, it’s easier to sacrifice production today to invest in generating ideas for future growth

  • if there are no limits to technological progress, there are no limits to economic growth

    • while the environment needs saving, CA GDP per capita has grown even though energy consumption hasn’t changed

  • ideas generate unlimited growth

    • they can be freely shared, nonrival, an idea doesn’t subtract from another

    • ideas don’t depreciate with use

    • ideas may promote other ideas

Why Institutions Matter for Growth

Property Rights

  • property rights determine who controls a tangible or intangible resource and being clearly defined helps people avoid fighting and gives incentive to get resources

  • without rights and a trusted enforcement system, nine creates wealth as they could lose it

  • people don’t want to invest if other partners can take of with the money or contracts won’t be enforced

  • government might not enforce rules or if corrupt be a problem

Government Stability

  • corruption and instability discourage investment and innovation since turmoil creates incentive for leaders to extract resources for personal gain

  • political uncertainty means people can’t count on receiving returns on investment

Efficiency of Regulation

  • need to have regulators to ensure business is doing good like following health standards, it helps businesses if customers know they can be trusted due to the government

  • usually harder to open businesses in poorer countries though they benefit more from entrepreneurship

  • too hard to invest or innovate because of red tape, corruption, no t enough enforcement of property rights

Policy to Encourage Innovation

  • clear property rights, well-functioning legal framework, regulations that protect the public and encourage entrepreneurship

  • incentives through intellectual property laws where you have the exclusive right to use your idea and others must pay you to use it for a period giving you a monopoly

    • can charge high for large profits as a benefit to innovating

  • subsidizing research and development reduces the cost of innovating