Achieving Economic Growth and Stabilizing the Economy

1
Achieving Economic Growth and Stabilizing the
Economy

• Heather Grob, PhD
• St. Martins University
• November 5, 2007

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Where are we now?

• Are we heading into a recession?
• Will we see more inflation?
• Will we see unemployment?
• What should the government do, if anything?

3
Why would you want to know about the changing
economy?

• Very rapid technological change favors the highly
  educated.
• You need to be prepared to create and assist in
  creativity.
• You will be asked to be change leaders.
• The value of education has in fact risen.

4
Theories of economic growth

• Traditional economic growth
• New growth theories creative destruction

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Who are these guys?
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Traditional Growth Theory -- Adam Smith

• Perfect competition is the main spur to economic
  activity, such that firms seek to produce at the
  lowest possible cost
• Division of labor allows increased productivity
• Government should promote free market interests

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Creative Destruction -- Joseph Schumpeter

• The drive to temporarily capture monopoly profits
  promotes replacement of old goods and
  livelihoods.
• Creativity and ideas count as economic activity.
• Government should protect intellectual property
  (patents)

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If the government does get involved in the
economy, what should be the goal?

• Control inflation
• Achieve acceptable level of growth
• Provide jobs and income
• Reduce swings in the business cycle

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Calculating the Real GDP

• Real GDP Nominal GDP X 100
• GDP deflator

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Calculating rates of economic growth

• Rate of growth Y2 Real GDP Y1 Real GDP
• Y1 Real GDP

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Rates of Economic Growth

• Rate of economic growth is the percent change in
  economic activity from one year to the next.
• Many people look at the real GDP, but there are
  other measures out there too.
• Are new products in fact a reflection of our
  economic progress?

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Stabilizing economic growth

• Limit swings/ hardships caused by unemployment
• Provide a more predictable environment

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The business cycle
Real GDP
Peak
Peak
Recovery
Recession
Trough
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Definition of a recession

• Real GDP decreases for at least 2 consecutive
  quarters.
• Rate of growth is negative.
• If the growth rate is 4, 2, 1 are we in a
  recession? No, we are still growing.
• If the growth rate is 4, -2, -1 are we in a
  recession? YES

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What should government do to increase growth?
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Industrial policy

• Gaining popularity among state local officials
  who wish to build industry clusters or
  high-tech jobs
• Idea is to subsidize specific industries that
  might be especially important for progress
• Is it effective, or is it just pork barrel
  politics?
• Should the government pick winners?
• If the government doesnt, who will?

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Boeing vs. Airbus

• U.S. complains that Airbus receives unfair
  subsidies from Europe. Those subsidies allow
  Airbus to set low prices and provide attractive
  financing options.
• Airbus says that it fends off a world monopoly
  and it claims that Boeing benefits from
  government assistance.
• Governments agreed to reduce support to the
  companies. (Then Boeings headquarter move
  forces States to compete over subsidies)
• Production strategies (A380 v. B-787
  Dreamliner)
• Success of company may depend on consumer and
  airline demand

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How fast can the economy grow?

• Mainstream view 2.5 growth per year
• Alternative 5 may be sustainable
• What are the implications for use of natural
  resources? For future generations?

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How economies grow economically

• Natural resources shift inputs toward
  production
• Human capital provide incentives to work,
  increase productivity
• Physical capital provide investment incentives
• Increase efficiency in production

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Natural resources are the first pillar of
economic growth

• Gifts usable in production
• Renewable vs. nonrenewable
• Will technology provide alternatives?

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ALTERNATIVE MEASURES OF GROWTH

• Measured Economic Welfare (MEW) was correlated
  with the GNP from 1929-1965 (Nordhaus and Tobin,
  1972)
• Index of Sustainable Economic Welfare (ISEW) was
  correlated for a time but turned negative after
  1980 (Costanza, Farley, Templet, 2002).

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Physical capital

• Computers, machinery, tools help us to produce
  goods and services
• Investment in physical capital can achieve
  productivity increases
• It involves and opportunity cost future
  consumption for forgone consumption today
• Government is a source of physical capital in
  that roads, bridges, airports and utilities
  comprise an infrastructure for human activity
  including production and that could increase
  efficiency

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Human Capital

• Improve knowledge, experience and skills of the
  workforce
• Teach people to adapt to changing situations and
  to innovate
• Formal training
• On the job experience

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What is inflation?

• A sustained or continuous rise in the general
  price level
• Measures of inflation include the CPI, GDP
  deflator, and others

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Causes of inflation

• Demand pull
• Demand outpaces supply
• Too much money chases too few goods
• Cost push
• Businesses raise prices
• Workers demand higher wages to keep up with
  inflation

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Impact of inflation on the real value of 10,000
Inflation
Annual Inflation Rate
Year 2 percent 4 percent 6 percent 8 percent 10
percent 2000 10,000 10,000 10,000 10,000 10,
000 2001 9,800 9,620 9,430 9,260 9,090 2002
9,610 9,250 8,900 8,570 8,260 2003 9,420
8,890 8,400 7,940 7,510 2004 9,240 8,550 7,
920 7,350 6,830 2005 9,060 8,220 7,470 6,81
0 6,210 2006 8,880 7,900 7,050 6,300 5,640
2007 8,710 7,600 6,650 5,830 5,130 2008 8,
530 7,310 6,270 5,400 4,670 2009 8,370 7,03
0 5,920 5,000 4,240 2010 8,200 6,760 5,580
4,630 3,860
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Who wins who loses from inflation?

• Loses
• Savers (non interest bearing)
• Taxpayers (including capital gains)
• Fixed income (retirees, workers with no or small
  pay raise)

• Wins
• Debtors
• Home owners
• Banks, credit card companies, leasing companies,
  repo cos.

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Measuring unemployment

• Unemployment rate number unemployed
• labor force

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Measuring unemployment

• Survey 60,000 households to gather information
• BLS counts only those who are willing, able and
  available for work
• Does not count the discouraged worker
• Does not count the underemployed

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3 Types of unemployment

• Frictional people change jobs
• Structural people lose jobs due to changing
  industry structures
• Cyclical people lose jobs due to changes in the
  business cycle
• Natural unemployment is where there is no
  cyclical unemployment
• Natural unemployment frictional plus
  structural unemployment

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Types of unemployment

• John is fired because he doesnt know how to
  operate the new robotic equipment. This is an
  example of
• a) frictional unemployment
• b) structural unemployment
• c) cyclical unemployment
• The answer is b!
• John may be entitled to special benefits

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Types of unemployment

• Kate decides to take a few months off before
  looking for a new job. She quit the old one to
  get her Masters. This is an example of
• a) frictional unemployment
• b) structural unemployment
• c) cyclical unemployment
• The answer is a!

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Types of unemployment

• Karen is laid off from her job at Chrysler.
  Shes been working for the company on and off for
  the last 5 years. This is an example of
• a) frictional unemployment
• b) structural unemployment
• c) cyclical unemployment
• The answer is c!
• Depending on the State in which she works, she
  may or may not be entitled to unemployment
  insurance.

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Who bears the burden of unemployment in the US?

• Teenagers (particularly male teens)
• People who are of African, Hispanic or American
  Indian descent
• Immigrants
• Contingent workers
• Jobs whose occupation or industry is highly
  sensitive to changes in the business cycle