CHAPTER 17: Growth and Productivity: Long-Run Possibilities

LEARNING OBJECTIVES

  • After reading this chapter, you should know:

    • LO17-1: The principal sources of economic growth.

    • LO17-2: The policy tools for accelerating growth.

    • LO17-3: The pros and cons of continued growth.

INTRODUCTION

  • Historical Context:

    • Visualize a world devoid of modern conveniences:

    • No smartphones, satellite TV, social media, streaming services, digital sound, or Starbucks.

    • Such conditions existed only 50 years ago with personal computers in their infancy.

    • The concept of websites was alien, as they were merely spider habitats.

    • Home videos and microwave popcorn were not yet staples.

    • The biotech revolution was in its infancy, with no blockbuster drugs available.

    • Economic Progress Evidence:

    • Development of new products signifies economic progress.

    • Increased production includes not just quantity but quality of goods and services.

    • Rising material living standards are a byproduct of this growth.

    • Contrasting Poverty:

    • The World Bank estimates that over 2 billion people live on less than $3 per day, highlighting stark inequities.

    • Many of the poorest nations are experiencing declining living standards.

    • Chapter Focus:

    • Shifts focus from the business cycle (short-run) to long-run economic growth.

    • Examines:

      • Importance of economic growth.

      • Mechanisms enabling an economy's growth.

      • The desirability and sustainability of continued growth.

THE NATURE OF GROWTH

  • Definition of Economic Growth:

    • Refers to increases in the output of goods and services.

    • Distinction exists in how output increases affecting economic welfare.

  • Types of Growth:

    • Short-Run Changes in Capacity Utilization:

    • Growth occurs via increased usage of existing productive capabilities.

    • Potential output is limited to the resources available and technological capabilities, represented by a production possibilities curve.

      • Figure 17.1a: Illustrates that inefficient points on the curve can be improved by using resources more effectively.

      • Movement to a point on the curve (e.g., from A to B) results in increased output by better resource utilization.

    • Long-Run Capacity Changes:

    • Sustained growth necessitates expanding productive capacity, shifting the production possibilities curve outward (e.g., shown in Figure 17.1b).

    • Such shifts indicate increases in potential GDP.

    • Persistent short-run capacity utilization growth provides limited output increases (e.g., 7% unemployment offers little room for expansion).

    • Economic growth, thus, is ultimately defined in terms of potential GDP changes.

  • Aggregate Supply and Demand:

    • Illustrates unique economic growth aspects:

    • Aggregate Supply (AS) Curves:

      • Short-run AS curve is sloped; long-run AS curve is vertical.

      • Macroeconomic stabilization policies can shift the aggregate demand (AD) curve to improve output and employment short-term.

      • However, these policies do not change the country's long-term productive capacity (long-run AS).

    • To achieve growth, the long-run AS curve must shift right (e.g., from LRAS₁ to LRAS₂) as shown in Figure 17.2.

NOMINAL VS. REAL GDP

  • Economic growth is predicated on changes in real GDP, not nominal GDP.

    • Nominal GDP can rise even amid declining output levels due to inflation factors.

    • Real GDP avoids inflation distortions, reflecting actual goods and services produced.

    • Example: 2008 witnessed a decrease in real GDP from $15,626 billion in 2007 to $15,605 billion in 2008, a decline of $21 billion, despite nominal GDP measurements suggesting growth.

    • Subsequent growth totaled an additional $6 trillion, providing a compelling case of relative economic growth.

MEASURES OF GROWTH

  • Growth Rate Calculation:

    • Expressed as a percentage, reflecting changes in real GDP between two periods divided by the total output in the base period.

    • For 2008, the productivity drop equated to a decrease of 0.13%.

    • In contrast, 2022 saw a real output growth of 2.1%.

  • Historical Context of U.S. Growth Rates:

    • Growth in GDP averaged 4.1% in the 1960s but slowed to 2.8% in the 1970s, with declines in output reflected in multiple years.

    • The 1982 recession significantly reduced GDP growth rates, reducing to an average of 2.5% in the 1980s.

    • The post-Great Recession period (2008-2009) saw a continued subdued pace of 2.5% annually until the pandemic recession of 2020 diminished output by 2.8%.

THE EXPONENTIAL PROCESS

  • Negative growth underscores serious implications (e.g., unemployment, layoffs), yet positive growth variances can appear inconsequential.

  • The significance of consistent growth accrues over time akin to banking interest—each year's growth compounds future growth.

  • Identifying growth as an exponential process, where:

    • At 2.5% growth, GDP doubles in 29 years; at 3.5%, it only takes 21 years.

    • Output differences between varying growth rates can equate to substantial output over a generational timeline.

GDP PER CAPITA: A MEASURE OF LIVING STANDARDS

  • GDP per capita calculated by total output divided by total population, serving as a key measure of living standards.

  • For instance, in 2023, GDP per capita was computed as:
    \text{GDP per capita} = \frac{27 \text{ trillion}}{340 \text{ million}} \approx 79,412.

  • Although GDP per capita offers a snapshot of available output, it does not denote equal distribution across individuals.

  • Sustaining growth in GDP per capita relies on output growth surpassing population growth, a benchmark the U.S. often meets despite historical slowdowns.

  • In stark contrast, developing nations experience challenges with both economic growth and population expansion, hindering living standards.

    • Example: Central African Republic, GDP per capita of only ~$450 alongside a population growth rate of 1.4%, exacerbating declining living standards.

SOURCES OF GROWTH

  • Growth Formula:

    • \text{Growth rate of total output} = \text{Growth rate of labor force} + \text{Growth rate of productivity}.

    • Future growth uncertainties primarily arise from unpredictable productivity changes.

  • Productivity Gains Sources Include:

    • Higher skills.

    • Increased capital-to-labor ratio.

    • Technological advancements.

    • Improved management.

  • Human Capital Investment:

    • Ongoing education improvements enhance the U.S. workforce, reflecting a growth in college-educated individuals from 8% in 1950 to 35% today.

    • Trends in demographic shifts, e.g. Baby Boomers retiring and Millennials' entry into the workforce, may temporarily dampen productivity growth.

  • Physical Capital Investment:

    • Increases in capital, or available machinery and technology, directly influence productivity, with the U.S. workers supported by $100,000+ of capital inputs.

    • Sustained productivity increases necessitate maintaining higher rates of capital investment relative to labor force growth.

  • Research and Development (R&D):

    • R&D is pivotal for productivity, constituting a key growth source through innovations in product development and production techniques.

    • Moore's Law exemplifies this growth, predicting exponential increases in processing capabilities every 18 months.

NEW GROWTH THEORY

  • New growth theory posits investing in ideas drives economic growth more than tangible assets.

  • Paul Romer asserts dissemination and creation of new ideas underpin growth, with R&D supporting this notion through advancements and technical innovations.

POLICY TOOLS

  • Supply-Side Policy Tools:

    • Capital investment growth necessitates aligning policy tools with supply-side strategies to facilitate long-run productive capacity increases.

  • Human Capital Development:

    • Education policies and immigration reforms are critical to augmenting America's human capital stock to drive GDP growth.

  • Investment Incentives:

    • Tax codes influencing depreciation schedules and tax credits for new investments incentivize physical capital investment.

    • Examples include tax cuts enacted during recent administrations aimed at stimulating investments.

  • Savings and Investment Rates:

    • Understanding savings as critical to future investments affects long-term growth perspectives; trends in household saving rates significantly impact this.

  • Fiscal Responsibility:

    • Government fiscal policies related to budget deficits and spending exert significant influence on long-run economic growth.

  • Stable Economic Expectations:

    • Economic assessments and expectations critically influence consumption and investment behaviors, underlining the need for perceptions of stability.

  • Institutional Context:

    • Secure property rights, open trade, and lower taxes in a robust institutional framework typically bolster economic growth.

SUMMARY

  • Economic growth is underpinned by the shifts in real GDP resulting from capacity utilization and long-term capacity improvements.

  • Average growth in the U.S. economy is ~3% annually, producing significant benefits over the long term.

  • Living standards are linked to GDP per capita and the growth differential of output vs. population growth.

  • Productivity advancements stem from multiple dimensions, with supportive governmental policies playing a vital role in this process.

  • Future growth concerns include limitations based on resource depletion and pollution, yet technological advantages can mitigate these concerns and enhance desirability for sustained economic growth.

KEY TERMS

  • production possibilities The alternative combinations of final goods and services that could be produced in a given period with all available resources and technology.

  • economic growth An increase in output (real GDP); an expansion of production possibilities.

  • real GDP The value of final output produced in a given period, adjusted for changing prices.

  • base year The year used for comparative analysis; the basis for indexing price changes.

  • growth rate Percentage change in real output from one period to another.

  • GDP per capita Total GDP divided by total population; average GDP.

  • labor force All persons over age 16 who are either working for pay or actively seeking paid employment.

  • employment rate The percentage of the adult population that is employed.

  • productivity Output per unit of input—for example, output per labor-hour.

  • human capital The knowledge and skills possessed by the workforce.

  • net investment Gross investment less depreciation.

  • crowding out A reduction in private sector borrowing (and spending) caused by increased government borrowing.

  • geometric growth An increase in quantity by a constant proportion each year.

  • arithmetic growth An increase in quantity by a constant amount each year.