Macroeconomics 28: Economic Growth

Macroeconomics                                                         Kostes

Chapter 28: Economic Growth

Economic Growth - as we have seen in earlier chapters, Economic growth and rising living standards are not routine or automatic. In fact, the whole phenomenon is barely two hundred years old. In addition, a look around the world shows that there are great disparities in living standards - even in countries where there have been decades of economic growth. And of course, there are the countries that have not experienced either of these phenomena yet.

Definitions of Economic Growth - there are two:

1)  An increase in real GDP occurring over some period

2)  An increase in real GDP per capita occurring over some period

With either definition, economic growth is calculated as a percentage per quarter (3-month period) or yearly.

First Definition – Example – in 2006, real GDP in the United States was $12,976 Billion. In 2007 it was $13, 254 Billion. So, the economic growth rate for 2007 was 2.1%. Growth rates are usually positive - but not always. In 2009, it was minus 2.4%. 

Second Definition - Per Capita - here Economists take into consideration the size of the population, or the amount of real output per person. Example – in 2006 the real GDP in the U.S was $12, 976 Billion and the population was 298.8 million people. This translates into the real GDP per capita of $43,432. In 2007 the real GDP per capita increased to $43,929. However, by this measure, that was only a 1.1% growth increase.   

By contrast, the real GDP per capita fell 3.3% in 2009 because of the recession

Table 28.1 on page 538 gives current and past GDP – Real and Per Capita

Note: the first definition is usually the one reported in the media - this is used because it reflects the political and military power of the nation. However, when comparing living standards, the second definition is far superior.

Example - China's GDP in 2008 was $4326 Billion compared to Denmark's $343 Billion. However, Denmark's real GDP per capita was $62,118 compared to China's lower $3,267. What accounts for the huge disparity?

Growth as a Goal – the expansion of total output relative to population results in rising wages and incomes, thus higher standards of living. An economy that is experience growth is better able to meet people's wants and needs, so opportunities for advancement are greater. And economic growth also enables a society to undertake programs to do things such as alleviate poverty, cultivate the arts and protect the environment without affecting existing levels of consumption, investment and the public good.

Components that qualify these numbers - these raw numbers have components that qualify them, and must be understood as well:

1)  Improved Products and Services -- real GDP and real GDP per capita do not fully account for improvements in goods and services, and so they understate the growth of economic well-being

2)  Added Leisure – the increase in real GDP that we have seen over the decades was accomplished despite increases in leisure time. Remember, the average work week has shrunk from 50 hours to 35.

3)  Other Impacts – the measures of growth do not account for the effect’s growth may have had on the environment or the quality of life. Destroying the environment or creating a more stressful work atmosphere and its effect on economic well-being does not show up in these metrics

Modern Economic Growth (MEG) – As we saw in chapter 26, rising living standards has occurred only since the Industrial Revolution. Before that this rare, if ever, occurred. A Greek peasant living in 300 B.C had much the same living standard as a Greek peasant living in 1500 A.D.

MEG is very recent and characterized by sustained and ongoing

increases in economic growth that can cause dramatic increases in the standard of living within less than a single lifetime.

Brief History - Economic historians place the start of the Industrial age around 1776, when Scottish inventor James Watt perfected a powerful and efficient steam engine. This engine could drive industrial factory equipment, steamships, and steam locomotives. This meant mass produced goods for the first time. Instead of taking days/weeks to be produced by local town craftsmen by hand and expensively, goods could be produced quickly, cheaply, in large numbers and miles away in factories

The result was a huge increase in long distance trade and major population shifts away from small towns and farm life into the major cities where the factories were built.

Steam power was later replaced by electrical power – which is where our society exists today – however, the stream of new technologies, inventions and applications of technology has made the last two hundred years totally and fundamentally different from the anything that went before.

The Uneven Distribution of Growth – Modern Economic Growth (MEG) has spread slowly and sparsely from its British birthplace. It first advanced into France, Germany, and other parts of Western Europe in the early 1800's, spreading to the United States, Canada and Australia in the mid 1800's. Japan began to industrialize by around 1870, but the rest of Asia did not follow until the mid-1900's – which also saw the Middle East, Latin & South America and follow suit in the late 1900's.

However, many areas of the world have not experienced modern economic growth until the last decade (Africa), and many other areas have experienced none.

The different “starting dates” for industrialization and MEG in various parts of the world are the main reason for the huge disparities in standards of living between the so called “rich” countries and the poor. The chart on page 547 gives an excellent illustration of this disparity over time.

Globalization, in one of its good manifestations, can help poorer countries new to industrialization and MEG to not only close the gap but to do it quickly. China's rise to the second largest economy on the planet is testimony to this fact

Note: also look at the reading insert “Consider this...” on page 541 for further information and insight into this topic.

Institutional Structures that Promote Growth – while poorer countries, at the dawn of their own industrial age, can catch up and reduce the gap between themselves and richer nations (who have been at it longer), there is a process to follow, and institutional structures that must be created for the process to succeed.

Economic historians have identified several of these “structures that are required to promote and sustain MEG

1)  Strong Property Rights - people will not invest if they believe

that thieves, bandits or even tyrannical governments will steal their investments or expected returns. This structure is necessary for this process to succeed. 

2)  Patents and Copyrights - these are necessary if a society wants a constant flow of innovative technology and sophisticated new ideas. Before such laws, inventors and authors often saw their ideas and inventions stolen. Protecting their ideas gives them strong financial incentive to invent and create.

3)  Efficient Financial Institutions – these are needed to channel the savings generated by households towards the businesses, entrepreneurs and inventors that do most of society's investing and inventing

4)  Literacy and widespread Education – without highly educated inventors, authors, etc. new ideas and new inventions/technologies do not get developed. And, without an adequately educated workforce, these ideas and technologies cannot be implemented and put to productive use

5)  Free Trade – promotes economic growth by allowing countries to specialize so that different types of output can be produced in the countries where they can be made most efficiently (Geographic specialization). Also, free trade allows for the rapid spread of ideas and technologies around the world for all to benefit - another positive feature of Globalization.

6)  Competitive Market System - under a market system prices and profits serve as signals to firms about what to make and how much. This enables them to decide on current production, and what to invest in to produce what they believe consumers will want in the future. Note: In a nutshell – these “structures” make up what Adam Smith described as his "Invisible Hand”

Note: These are also illustrations of the fact that Capitalism and the Market Economy cannot operate successfully without the “Rule of Law"

Determinants of Growth – there are six factors that directly affect the rate of economic growth Supply Factors - the First Four of these determinants are related to the physical ability of the Economy to expand, and are called supply factors: What enables expansion is:

1)   Increases in the quality & quantity of Natural Resources

2)   Increases in the quantity & quality of Human Resources

3)   Increases in the supply (or stock) of capital goods

4)   Improvements in technology

5)   The Demand Factor - to achieve the higher production potential created by the supply factors, households, businesses, and governments must purchase the economy's expanding output of goods and services

6)   The Efficiency Factor: to reach full production potential a society must achieve economic efficiency as well as full employment

a)   The economy must use its resources in the least costly way (productive efficiency) to produce the specific mix of goods and services that maximize people's economic wellbeing (allocative efficiency).

b)  The ability to expand production, together with the full use of available resources is not sufficient for achieving maximum possible growth; it also requires the efficient use of those resources

Note: so, understand that Supply, Demand and Efficiency are all related. Widespread inefficiency in the use of resources (efficiency factor) can drive higher costs of goods and services, which lower profits. This in turn may slow innovation and reduce capital (supply factors), which could drive higher unemployment and reduced consumption (demand factor).

The Rise in the Average Rate of Productivity Growth – specifically, labor productivity growth.  If we look at productivity growth over the period - 1973 – 1995 -- labor productivity only grew at a 1.5% clip. However, from 1995 to 2009 – productivity growth averaged 2.8% per year. Many Economists believe that this growth rate resulted from a new wave of technological innovation and global competition.

This increase in labor productivity is important because real output, real income and real wages are linked to labor productivity. So, the Economy with a solid labor productivity growth rate increases its average real hourly wage, which includes fringe benefits (health care, vacation, pensions).

The Economy's income per hour is equal to its output per hour -- so labor productivity growth is the economy's main route for improving the living standards of its workers Given what you know about the current work environment, are there any “alarm bells” going off in anyone's mind right now?

Food for Thought:

1)  1960-1989: GDP Growth >= 3% 21 out of 30 times

2)  1990-2020: GDP Growth >= 3% only 9 out of 30 times – with all 9 of those years happening between 1995 - 2007.  And < 3% 13 straight years in a row (2007-2020) - not including the pandemic.

3)  This despite the presence of Four (4) Trillion-dollar corporations that came of age in the 1990s.

a.     Google (Alphabet)

b.    Apple

c.     Microsoft

d.    Amazon

4)  Worst Wealth Inequality in 100 years

Textbook’s Reasons for the 1995-2007 Rise - let's look at the specific reasons the text gives us for this increase in the labor productivity rate:

1)  Microchip and Information Technology – the core element of the labor productivity rate increase is the explosion of entrepreneurship and innovation based on the microprocessor or microchip. Some observers compare the impact of the microchip to that of electricity, the automobile, the telephone, and television. Perhaps the greatest idea of significance was to connect the millions of personal computers and laptops which drove the development of the Internet.

2)  New Firms and Increasing Returns - hundreds of start-up firms advanced the various aspects of the new information technology – Apple and Dell (personal computers), Microsoft and Oracle (computer software), Cisco Systems (Internet Switching systems), Yahoo and Google (Internet Search Engines), and eBay and Amazon (electronic commerce).

This was not limited to start-ups. Established firms as well as new companies took advantage of this innovation bonanza. Here are some of the different sources of increasing returns and economies of scale

a)   More Specialized Inputs – firms can use more specialized and therefore more productive capital and workers – example, a new ecommerce company can use specialized inventory management systems and hire specialized personnel like accountants and system maintenance experts.

b)  Spreading the Development Costs - Firms can spread development costs over greater output - this is the classic economies of scale example

c)    Simultaneous Consumption - satisfying large numbers of customers at the same time. A car or a gallon of gas needs to be produced for every buyer. However, a software program needs to be produced only once - and it is sold to millions of buyers, same for electronic books, movies, and information

d)  Network Effects – software and internet service become more beneficial the greater the number of households or businesses that buy them - you increase the value of a product to each user, including existing users, as the total number of users increases

e)   Learning by Doing - tasks that used to take firms hours may take only minutes once the methods are perfected

Global Competition - The new information technologies have “shrunk the world” and made it necessary for all firms to lower their costs and prices and to innovate in order to remain competitive. By removing trade barriers (tariffs, duties, etc.) organizations like the European Union (EU) and the World Trade Organization (WTO), and World agreements like NAFTA's free trade zones have increased competition because of their activities.

           Two Questions – that might sound unrelated.

1)  What happened to Growth? Why has the American Economy been unable to grow consistently at a 3% or greater level – when it did that for 130 years prior to the 21^st century (1870-1999)?  What changed?

a.    Focus of Technology Innovation changed.

                                     i.            Innovation exploded in the digital industry to the exclusion of other industries.

                                  ii.            The Digital Sector only accounts for 7% of GDP growth – despite the presence of 4 trillion-dollar corporations

                               iii.            As a result, lack of innovation and overall investment in Manufacturing, Transportation and Infrastructure caused employment in these industries to shrink.  In fact, it caused the industries themselves to shrink.

                                iv.            More middle-class jobs were created in these industries prior to 2000 than in the service industries post 2000.

b.    America became a Service Economy vs. a Manufacturing Economy:

                                     i.            So, the kinds of jobs created changed – manufacturing & infrastructure jobs were better paying, had more benefits and promoted skill growth.  Most Service jobs (in retail, fast food, e-commerce, and the “gig” economy) – are low paying, do not usually grow marketable skills, are short-term, contract driven, and often - temporary.

2)  Is Growth Desirable or Sustainable - critics of growth say growth and industrialization result in pollution, climate change, ozone depletion and many other environmental problems? They also stress that while economic growth can make us a “better living' it cannot give us a “good life” necessarily. Finally, such critics doubt that such large-scale economic growth is sustainable. The earth has a finite number of natural resources being consumed at an alarming rate. Higher rates of growth will simply speed up the degradation and exhaustion of these natural resources.

              In Defense of Growth – basic defense – primary path to greater material abundance and higher living standards is in more growth. Growth also enables the nation to improve its infrastructure, enhance the care of the sick, the elderly, and the disabled. Growth may be the only real way to resolve such social issues as the elimination of poverty and improve the condition of many people in danger of falling into poverty.

Finally, Economists say that economic growth has to do with the expansion and application of human knowledge and information - not of extractable and limited natural resources. In this view, economic growth is only limited by human imagination - which, many believe is unlimited.

Prospects for Lasting Productivity Growth - Conclusion: Time will tell.  We must get answers and then develop solutions to the two questions and situations described above