Ch2

Chapter 2: Economic Growth

2.1 Economic Growth Overview

  • Definition: Economic growth refers to an increase in the level of real GDP per person over time, which is essential for improving living standards.

  • Models Reviewed:

    • Malthusian Model: Predicts stagnant living standards at subsistence levels due to population growth.

    • Solow Model: Explains growth via capital accumulation but not sustained long-term growth; highlights need for human capital and technological advances.

2.1.1 Evidence on Economic Growth

  • Real GDP per Person: Denoted as (y_t = \text{GDP} / \text{Population}), with the growth rate given by (g_t = (y_t - y_{t-1}) / y_{t-1}).

  • Historical Data: U.S. real GDP per person increased over 10 times from 1870 to 2018, reflecting significant growth.

2.1.2 Measuring Economic Growth

  • Per capita Income Growth: Actual growth rate not represented simply by the gradient of GDP vs. time; logarithmic scaling provides a better representation.

  • Mean Growth Rates: From 1870 to 2000, average growth rate in the U.S. was 1.75%. Differences in growth rates significantly affect income levels in the long run.

  • Rule of 70: An approximation method stating that if growth occurs at (g%), income doubles in approximately (70/g) years.

2.1.3 Importance of Growth

  • Significance of Growth Rates: Even small differences in sustained growth rates can result in substantial differences in income over time.

  • Example Scenarios:

    • If growth rate was 0.75%, 2000 income would be $10,000.

    • If growth rate was 2.75%, 2000 income would be $120,000.

2.1.4 Historical Context of Economic Growth

  • Stagnation: For most of human history, economies stagnated with fluctuating GDP due to population counteracting growth.

  • Modern Growth: Occurred predominantly over the last 300 years with some countries realizing steady growth.

2.1.5 Income Distribution Across Countries

  • Pre-19th Century: Income differences across countries were considerably smaller than today.

  • Current Differences: Significant disparities in income, often 10-20 times, between rich and poor countries.

  • World Income Distribution (2017): Documented the challenges faced by poorer nations in income levels.

2.1.6 Convergence vs. Divergence

  • Convergence: Explains if poorer nations can grow faster than richer ones.

    • Absolute Convergence: Suggests poor grow faster than rich.

    • Conditional Convergence: Poorer countries grow faster within similar conditions and fundamentals.

  • Empirical Evidence:

    • Post-Second World War: Conditional convergence among similar countries but no absolute convergence globally.

2.1.7 Implications of Solow Model on Cross-Country Income Differences

  • Two Predictions:

    1. Countries with similar fundamentals converge in income over time.

    2. Differences in saving rates yield differences in long-term income levels.

  • Steady State Predictions: Long-term income levels depend on capital accumulation.

  • Conclusion on Income Levels: Limited ability of the Solow model to explain income differences of magnitude observed in the real world, suggesting other factors (like TFP) play significant roles.

2.2 Technological Progress

  • Role of Technology: Continuous technological progress shifts the production function, enabling sustained economic growth.

  • Constant Growth in Technology: Implies that economies can experience long-run growth as long as capital enhances productivity.

  • Endogeneity of Growth: Models showcasing endogenous growth stems from increased capital and human capital leading to enhanced productivity across the economy.

2.3 Human Capital

  • Definition: Human capital consists of the knowledge, skills, and education embodied in the workforce.

  • Measurement: Average years of schooling and training influence productivity and economic output.

  • Growth Source: Accumulating human capital can lead to long-term economic growth similar to physical capital.

    • Human Capital Dynamics: Individual and overall human capital can grow if proper investments are made in education and training.

2.4 Research and Development (R&D)

  • Role in Growth: R&D efforts can lead to the discovery and implementation of new technologies.

  • Investment and Returns: The economic outcome depends on societal incentives and institutional frameworks guiding R&D.

2.5 Climate Change Impact on Economic Growth

  • Economic Disruption: Climate change affects productivity and economic planning, potentially elevating costs.

  • Long-term Considerations: Strategies for adapting to climate change must consider capital depreciation and technological shifts.

2.6 The AK Model

  • Acceptance of Constant Returns: This model posits that input growth leads to proportional output growth with no diminishing returns to capital.

  • Endogenous Growth: Intense saving and investment behaviors lead to sustained long-run growth independent of capital saturation.

2.7 Learning-by-Doing

  • Concept: Productive practices and experiences enhance knowledge, leading to increased productivity and economic growth.

  • Economic Implications: Firms accumulate knowledge that benefits the overall economy, underscoring the need for ongoing capital investment.

2.8 International Technology Transfer

  • Knowledge Sharing: Differences in ability to imitate or acquire technology can impact growth rates across different economies.

  • Inefficiencies: Barriers to technological transfer and intellectual property rights can inhibit potential growth.