Production and Growth (Chapter 26) Notes

Economic Growth around the World

• Variations in the Standard of Living (1 of 2)

  • Living standards vary widely from country to country.

  • Average income in a rich country (the U.S., Japan, or Germany) is about $10$ times the average income in a poor country (e.g., India, Nigeria, or Nicaragua).

  • Differences are reflected in large differences in quality of life: nutrition, housing, healthcare, life expectancy, and so on.

  • Within a country, over time: The U.S. has Real GDP per person growth of about $2 ext{ extiks{2}}$ per year (for the past $100$ years).

• Variations in the Standard of Living (2 of 2)

  • Ranking of countries by income changes substantially over time.

  • Poor countries are not necessarily doomed to poverty forever; e.g., Japan’s incomes were low in $1860$ and are high now.

  • Rich countries can’t take their status for granted; they may be overtaken by poorer but faster-growing countries.

• Table 1: The Variety of Growth Experiences (Real GDP per person in 2020 dollars)

  • China (1900–2020): Beginning $834$, End $17{,}312$, Growth rate $2.56 ext{ ext}$ per year.

  • Japan (1890–2020): Beginning $1{,}751$, End $42{,}197$, Growth rate $2.48 ext{ ext}$ per year.

  • Brazil (1900–2020): Beginning $907$, End $14{,}836$, Growth rate $2.36 ext{ ext}$ per year.

  • Mexico (1900–2020): Beginning $1{,}350$, End $18{,}833$, Growth rate $2.22 ext{ ext}$ per year.

  • Indonesia (1900–2020): Beginning $1{,}038$, End $12{,}074$, Growth rate $2.07 ext{ ext}$ per year.

  • Germany (1870–2020): Beginning $2{,}544$, End $53{,}694$, Growth rate $2.05 ext{ ext}$ per year.

  • Canada (1870–2020): Beginning $2{,}766$, End $48{,}073$, Growth rate $1.92 ext{ ext}$ per year.

  • India (1900–2020): Beginning $786$, End $6{,}454$, Growth rate $1.77 ext{ ext}$ per year.

  • United States (1870–2020): Beginning $4{,}668$, End $63{,}544$, Growth rate $1.76 ext{ ext}$ per year.

  • Argentina (1900–2020): Beginning $2{,}671$, End $20{,}768$, Growth rate $1.72 ext{ ext}$ per year.

  • Bangladesh (1900–2020): Beginning $726$, End $5{,}083$, Growth rate $1.64 ext{ ext}$ per year.

  • Pakistan (1900–2020): Beginning $859$, End $4{,}877$, Growth rate $1.46 ext{ ext}$ per year.

  • United Kingdom (1870–2020): Beginning $5{,}601$, End $44{,}916$, Growth rate $1.40 ext{ ext}$ per year.

Productivity: Its Role and Determinants

• Productivity defined

  • Productivity: the quantity of goods and services produced from each unit of labor.

  • Key determinant of living standards: when productivity grows, real GDP is large and incomes are high.

  • An economy’s income is its output.

  • A nation can enjoy a high standard of living only if it can produce a large quantity of goods and services.

• What productivity depends on (determinants)

  • Physical capital per worker: $rac{K}{L}$

  • Human capital per worker: $rac{H}{L}$

  • Natural resources per worker: $rac{N}{L}$

  • Technological knowledge: society’s understanding of the best ways to produce goods and services.

  • Terms: physical capital, human capital, natural resources, and technological knowledge are the core determinants of productivity.

• Quick definitions from the chapter

  • Physical capital: the stock of equipment and structures used to produce goods and services.

  • Human capital: knowledge and skills that workers acquire through education, training, and experience.

  • Natural resources: inputs into production provided by nature (land, rivers, mineral deposits).

  • Technological knowledge: society’s understanding of the best ways to produce goods and services; can be common knowledge or proprietary.

How Productivity Is Determined (1 of 2)

• Physical capital per worker: capital accumulation raises productivity but subject to diminishing returns.

• Human capital per worker: education, training, and experience increase productivity.

• Natural resources per worker: availability of land and resources affects productivity.

• Technological knowledge: advances that boost productivity and allow more output from the same resources.

How Productivity Is Determined (2 of 2)

• Types of knowledge

  • Common knowledge: after one person uses it, everyone becomes aware of it.

  • Proprietary knowledge: known only by the company that discovers it.

• Any advance in knowledge that boosts productivity and allows society to get more output from its resources is included in technological knowledge.

Active Learning 1: Discussion Questions

• Which policies would be most effective at boosting growth and living standards in a poor country over the long run?

  • Offer tax incentives for investment by local firms

  • Offer tax incentives for investment by foreign firms

  • Give cash payments for good school attendance

  • Crack down on government corruption

  • Restrict imports to protect domestic industries

  • Allow free trade

26-3 Economic Growth and Public Policy

• Public policy and growth

  • A society’s standard of living depends on its ability to produce goods and services.

  • Productivity depends on: $rac{K}{L}, rac{H}{L}, rac{N}{L}, ext{and } ext{technological knowledge}$

  • Policymakers consider what government policy can do to raise productivity and living standards.

Saving and Investment

• To raise future productivity, encourage saving and investment.

  • Invest more current resources in the production of capital.

  • Trade-off: sacrifice current consumption to increase future consumption.

• Higher savings rate → more resources to make capital goods → capital stock increases.

Diminishing Returns and the Catch-Up Effect (1 of 2)

• Diminishing returns: the benefit from an extra unit of an input declines as the quantity of the input increases.

• In the long run:

  • Higher saving rate leads to a higher level of productivity and a higher level of income.

  • This faster growth is temporary, due to diminishing returns to capital.

Catch-Up Effect (2 of 2)

• Catch-up effect: the property whereby countries that start off poor tend to grow more rapidly than countries that start off rich.

• Why this happens

  • Accumulation of capital is subject to diminishing returns: the more capital a country has, the less additional output it gets from an extra unit of capital.

  • Poor countries have more to gain from capital investment relative to their existing stock.

• Growth patterns

  • Poor countries often have low productivity and high returns on investment in capital, so they can grow quickly with some investment.

  • Rich countries have high productivity, so additional capital investment yields smaller gains.

Investment from Abroad (1 of 2)

• Domestic savings and foreign investment increase the economy’s capital stock.

• Foreign investment types

  • Foreign direct investment (FDI): capital investment owned and operated by a foreign entity.

  • Foreign portfolio investment (FPI): investment financed with foreign money but operated by domestic residents.

Investment from Abroad (2 of 2)

• Benefits from investment

  • Some benefits flow back to foreign capital owners.

  • Increases the economy’s stock of capital, raising productivity and wages.

  • Brings state-of-the-art technologies developed in other countries.

  • Particularly beneficial for poor countries that cannot generate enough saving to fund investment projects themselves.

World Bank and IMF

• World Bank: Encourages flow of capital to poor countries; funds from advanced countries; makes loans to less developed countries.

• IMF: Established to promote the common goal of economic prosperity.

Education

• Education is an investment in human capital.

  • Gap between wages of educated and uneducated workers.

  • Opportunity cost: wages forgone to attend education.

  • Education conveys positive externalities.

• Subsidies to human-capital investment: Public education.

• Problem for poor countries: Brain drain (educated individuals leaving for better opportunities elsewhere).

Health and Nutrition (1 of 2)

• Health care expenditure as investment in human capital: healthier workers are more productive.

• In countries with significant malnourishment, raising caloric intake raises productivity.

• Historical note: 1962–1995, caloric consumption rose $44 ext{ ext}$ in South Korea, and economic growth was spectacular.

• Nobel laureate Robert Fogel: $30 ext{ ext}$ of Britain’s growth from $1790$–$1980$ was due to improved nutrition.

Health and Nutrition (2 of 2)

• Vicious circle and virtuous circle

  • Vicious circle: countries are poor partly because populations are not healthy, while populations are not healthy partly because they are poor and cannot afford adequate healthcare and nutrition.

  • Virtuous circle: policies that lead to more rapid economic growth would improve health outcomes, which in turn would further promote economic growth.

Property Rights and Political Stability (1 of 2)

• To foster economic growth, protect property rights (the ability of people to exercise authority over the resources they own).

• Prerequisite for the price system to work.

• Courts: Enforce property rights; promote political stability.

Property Rights and Political Stability (2 of 2)

• Major problem: lack of property rights.

  • Contracts hard to enforce.

  • Fraud and corruption often go unpunished.

  • Firms may bribe government officials for permits.

  • Political instability (frequent revolutions, coups) creates uncertainty about whether property rights will be protected in the future.

Free Trade (1 of 2)

• Trade can make everyone better off.

• Inward-oriented policies aim to raise living standards by avoiding interaction with other countries (tariffs, limits on foreign investment).

• Outward-oriented policies promote integration with the world economy (elimination of restrictions on trade or foreign investment).

Free Trade (2 of 2)

• Trade has similar effects as discovering new technologies: it improves productivity and living standards.

• Countries with inward-oriented policies have generally failed to create growth (Argentina in the 20th century).

• Countries with outward-oriented policies have often succeeded (South Korea, Singapore, Taiwan).

Ask the Experts: Innovation and Growth

• “Future innovations worldwide will not be transformational enough to promote sustained per-capita economic growth rates in the United States and western Europe over the next century as high as those over the past 150 years.”

• Source: IGM Economic Experts Panel, February 11, 2014.

Research and Development

• Technological progress: main reason why living standards rise over the long run.

• Knowledge is a public good: ideas can be shared freely, increasing productivity for many.

• Policies to promote technological progress:

  • Patent laws

  • Tax incentives or direct support for private sector R&D

  • Grants for basic research at universities

Active Learning 2: Why Is So Much of Africa Poor? (1 of 2)

• In 2020, GDP per person in sub-Saharan Africa was only $3{,}821$ (22 ext{%} of the world average).

• 40 ext{%} of the population lives on less than $1.90$ per day.

• Prompt: Discuss some of the determinants of productivity that may explain low economic development in this area.

Active Learning 2: Why Is So Much of Africa Poor? (2 of 2) – Answers

• Low capital investment

• Low educational attainment

• Poor health

• High population growth

• Geographic disadvantages

• Restricted freedom

• Rampant corruption

• The legacy of colonization

26-4 Conclusion: The Importance of Long-Run Growth

• Ten Principles of Economics: a country’s standard of living depends on its ability to produce goods and services.

• Policymakers can influence growth by:

  • Increasing productivity through rapid accumulation of the factors of production and ensuring these factors are employed as effectively as possible.

• Economists’ view: government can support the invisible hand by maintaining property rights, political stability, and subsidizing specific industries for technological progress.

Think-Pair-Share Activity

• You are discussing with other youths about a perceived lack of growth in the United States relative to Japan, South Korea, and China.

• Questions to consider:

  • Have you learned anything in this chapter that would make you question your roommate’s assertion?

  • Is the so-called “Japanese miracle” truly a miracle or explainable?

  • Are the high growth rates in these Asian countries without cost?

Self-Assessment

• In what way is your college degree a form of capital?

Summary

• Summary: Review objectives for this presentation (link provided in the original slides).

Closing Notes

• This chapter emphasizes that long-run growth hinges on productivity, which in turn depends on capital, human capital, natural resources, and technological knowledge.

• Public policy, international trade, education, health, property rights, and R&D all play pivotal roles in determining growth trajectories and living standards.