Economic growth and living standards

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Economic growth and living standards
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Long-Term Growth Trends (US)
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Long-Term Growth Trends

• Many developing countries in Africa, Central
  America, and South America stagnated during the
  1980s, and have grown slowly since.
• They have fallen further behind the United States.

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Long-Term Growth Trends

• Other formerly low-income nationsHong Kong,
  Korea, Singapore, and Taiwan are exampleshave
  grown very rapidly and have caught up or are
  catching up with the United States

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The problem of economic development

• Lucas defines it as the problem of accounting for
  the observed pattern, across countries and across
  time, in levels and rates of growth of per capita
  GDP
• Motivation The diversity across countries in per
  capita income is too great to be believed

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The problem of economic development (contd)

• Is there some action the govmt of India could
  take to grow as Japan? If so, what exactly? If
  not, what is it about the nature of India that
  makes it so
• Consequences for human welfare are staggering.
  Once one starts to think about them, it is hard
  to think about anything else!

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Alternative measures of development

• United Nations Development Programme Development
  is about expanding the choices people have to
  lead lives that they value
• The most basic things for human development are
• To lead long and healthy lives
• Be knowledgeable
• Have resources for a decent standard of living
• Participate in the community

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Very different income, similar HDI
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Our approach

• Accounting for differences in GDP is not the only
  thing that matters
• But it certainly is an important one (no
  extremely poor country has a high HDI)

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In the long-run small differences in growth rates
matter a lot

• Australia was much richer than Japan in 1870
• Over 1870-2000 Japan grew at an annual rate of
  2.5, while Australia grew at 1.1
• As a result, Japan is now richer than Australia

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What happens to GDP under different growth rates?
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Important questions

• Why some countries are rich and some countries
  are poor (at one point in time)?
• What is the engine driving economic growth (what
  is the force driving the time series behavior of
  GDP)?

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Methodology

• First accounting decomposition
• Identify what makes GDP to be so different across
  distinct countries
• Once we identify the force driving the
  cross-country disparity we can develop more
  effective economic policies and better economic
  models

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Growth accounting

• GDP is quantity of goods produced in a given
  period
• What determines how many goods can be produced?

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Inputs and technical constraints

• Inputs
• Labor (L)
• Machines (capital stock K)
• Technical constraints
• Statistical studies suggest
• gives a good representation of the aggregate
  technical capabilities of an economy (where Y is
  maximum output possible given inputs K and L, and
  a is a positive number smaller than one)

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Accounting for the observed differences in output
per worker

• Growth accounting divides growth in output per
  worker in two components
• Growth in capital per hour of labor (K/L)
• Technological change (A)
• Implication of the above formula Any growth not
  accounted for by growth in capital is allocated
  to technological change, so this category is a
  broad catchall concept.

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Conclusions

• That different countries have different levels
  (or growth rates) of output per worker can only
  be due to
• Differences in the level (or growth) of capital
  per worker (K/L)
• or differences in TFP
• What is more important?
• Empirical question that can only be answered by
  looking at each countrys data

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Growth Accounting (intuitive graphical view)

• Productivity Curve relationship between real GDP
  per hour of labor and the amount of capital per
  hour of labor, with technology held constant.

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Growth Accounting

• An increase in capital per hour brings a movement
  along productivity curve.
• Technological change shifts the productivity
  curve.
• Only two things matter
• Capital per hour, and technological change

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Growth Accounting

• The shape of the productivity curve reflects the
  law of diminishing returns.
• The law of diminishing returns states that, as
  the quantity of one input increases with the
  quantities of all other inputs remaining the
  same, output increases but ever smaller
  increments.

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Diminishing returns
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One third rule (empirical regularity)

• Robert Solow discovered that diminishing returns
  are well described by the one-third rule with no
  change in technology, on the average, a 1 percent
  increase in capital per hour of work brings a
  one-third of 1 percent increase in output per
  hour of labor.
• Example Assume technology remains fixed and the
  capital stock of the US economy increases by 30,
  what would you expect will happen to output per
  hour as a result of this increase in capital?

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Growth Accounting An application to the US
economy

• The productivity function and one-third rule can
  be used to study productivity growth in the
  United States.

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Growth Accounting

• From 1963 to 1973 a large increase in
  productivity (output per hour) resulted from
  rapid technological change and a modest increase
  in capital per worker.

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Growth Accounting

• From 1973 to 1983 productivity growth slowed
  because the pace of technological change slowed
  down.
• Capital per worker continues to grow at a similar
  pace to that of the previous decade.

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How to achieve faster growth conclusions from
the graphical approach

• Growth accounting tell us that to achive faster
  economic growth we must either increase the
  growth rate of capital per hour of labor or
  increase the pace of technological advance.
• What policies may achieve faster growth?

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Resources are scarce

• Objective now determine which policy will have
  the largest positive impact on GDP per person (or
  on its growth rate).
• Data quantitative analysis are required to
  answer

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Growth accounting (quantitative apporach)

• One simple tool. Use the properties of
  logarithms. In particular recall that
• ln(x)-ln(y) percentage
  differencebetween x and y
• Example If ln(GDP1)-ln(GDP2)0.02 that means
  GDP1 is approximately 2 larger than GDP2

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Accounting for cross-country ALP disparity
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Accounting for cross-country ALP disparity
Which in words means Percentage difference
between x and ys ALP Percentage difference
between x and ys TFP a(percentage difference
between x and ys capital)