Growth, Productivity, and the Wealth Of Nations

1
Growth, Productivity, and the Wealth Of Nations

• Chapter 8

2
Laugher Curve

• We have two classes of forecasters
• Those who don't know, and those who don't know
  they don't know.
• John Kenneth Galbraith

3
General Observations about Growth

• Growth increases the economys potential output.

4
Growth and the Economys Potential

• Growth is an increase in the amount of goods and
  services an economy produces.
• Growth is an increase in potential output.

5
Growth and the Economys Potential

• Potential output the highest amount of output
  an economy can produce from the existing
  production function and existing resources.

• When an economy is at its potential output, it is
  operating on its production possibility curve.

6
Growth and the Economys Potential

• Long-run growth focuses on supply.

• It assumes Says Law supply creates its own
  demand.

7
Growth and the Economys Potential

• In the short run, economists consider potential
  output fixed.

• They focus on how to get the economy operating at
  its potential if it is not.

8
Importance of Growth for Living Standards

• Growth improves living standards.
• It makes more goods available to more people.
• Because of compounding, long-term growth rates
  matter a lot.

9
Importance of Growth for Living Standards

• The Rule of 72 is used to determine how long it
  takes for income to double at different growth
  rates.

• The Rule of 72 the number of years it takes for
  a certain amount to double in value is equal to
  72 divided by its annual rate of increase.

10
Markets, Specialization, and Growth

• Markets, specialization and the division of labor
  increase productivity and growth.
• Specialization the concentration of individuals
  on certain aspects of production
• Division of labor the splitting up of a task to
  allow for specialization of production.

11
Economic Growth, Distribution, and Markets

• Markets are often seen to be unfair because of
  the effect they have on the distribution of
  income.

12
Economic Growth, Distribution, and Markets

• Markets may not provide equality of income but
  they make the poor better off.

• There is strong evidence that the poor benefit
  enormously from the growth that markets foster.

13
Economic Growth, Distribution, and Markets

• Just because the poor benefit from growth does
  not mean they might not be better off if income
  were distributed more in their favor.

14
Cost of Goods in Hours of Work
15
Per Capita Growth

• Per capita output is total output divided by
  total population.
• Per capita growth means producing more goods and
  services per person.

16
Per Capita Growth

• Per capita growth equals the percent change in
  output minus the percent change in population

Per capita growth change in output -
change in population
17
Per Capita Growth

• In many developing nations, the population is
  rising faster than GDP, resulting in a lower per
  capita growth rate.

18
Per Capita Growth

• Some economists have argued that per capita
  (mean) output is not what we should be focusing
  on.

• We should focus on median income instead.

19
Per Capita Growth

• Median income is a better measure because it
  takes into account how income is distributed.

20
Per Capita Growth

• If the growth in income goes mostly to a small
  minority of individuals, the mean will rise but
  the median will not.

• Because statistics on median income is generally
  not collected, economists use per capita income.

21
The Sources of Growth

• Economists identify five important sources of
  growth
• Capital accumulation investment in productive
  capacity.
• Available resources.
• Growth compatible institutions.
• Technological development.
• Entrepreneurship.

22
Investment and Accumulated Capital

• Years ago it was thought that physical capital
  and investment were the keys to growth.
• The flow of investment lead to the growth of the
  stock of capital.

23
Investment and Accumulated Capital

• Capital accumulation does not necessarily lead to
  growth.

• Products change, and useful buildings and
  machines in one time period may be useless in
  another.

24
Investment and Accumulated Capital

• Capital is much more than machines it includes
  human and social capital.

• Human capital the skills that are embodied in
  workers through experience, education, on-the-job
  training.
• Social capital the habitual way of doing things
  that guides people in how they approach
  production.

25
Investment and Accumulated Capital

• All economists agree that the right kind of
  investment at the right time is a central element
  of growth.

26
Available Resources

• For an economy to grow it will need resources.
• What constitutes a resource at one time may not
  be a resource at another time.

27
Available Resources

• Technology plays an enormous role here.

• Greater participation in the market is another
  way by which available resources are increased.

28
Growth-Compatible Institutions

• Markets and private ownership of property foster
  economic growth.
• When individuals get much of the gains of growth
  themselves, they work harder.

29
Growth-Compatible Institutions

• Another growth-compatible institution is the
  corporation.

• Because of limited liability, corporations give
  owners and incentive to invest their savings in
  large enterprises.

30
Growth-Compatible Institutions

• Mercantilist economic policies inhibit economic
  growth.

31
Technological Development

• Growth isnt just getting more of the same thing.
• Its also getting some things that are different.

32
Technological Development

• Growth involves changes in technology.

• Technology changes the way we make goods and
  supply services, and in the goods and services we
  buy.

33
Entrepreneurship

• Entrepreneurship is the ability to get things
  done.
• That ability involves creativity, vision, and a
  talent for translating that vision into reality.

34
Turning the Sources of Growth into Growth

• In order to be effective, the five sources of
  growth must be mixed in the right proportions.

35
Turning the Sources of Growth into Growth

• It is the combination of investing in machines,
  people, and technological change that plays a
  central role in the growth of any economy.

36
The Production Function and Theories of Growth

• The production function shows the relationship
  between the quantity of inputs used in production
  and the quantity of output resulting from
  production.

37
The Production Function and Theories of Growth

• The production function for growth has land,
  labor, and capital as factors of production.

• A is an adjustment factor that captures the
  effect of technology.
• Output A f(Labor, Capital, Land)

38
Describing Production Functions

• Scale economies describe what happens in a
  production function when all inputs increase
  equally.
• Constant returns to scale.
• Increasing returns to scale.
• Decreasing returns to scale.

39
Describing Production Functions

• Constant returns to scale means that output will
  rise by the same proportionate increase in all
  inputs.

40
Describing Production Functions

• Increasing returns to scale occurs when output
  rises by a greater proportionate increase as all
  inputs.

41
Describing Production Functions

• Decreasing returns to scale occurs when output
  rises by a smaller proportionate increase as all
  inputs.

42
Describing Production Functions

• Diminishing marginal productivity describes what
  happens when more of one input is added without
  increasing any other inputs.

43
Describing Production Functions

• The law of diminishing marginal productivity
  states that increasing one output, keeping all
  others constant, will lead to smaller and smaller
  gains in output.

44
The Classical Growth Model

• The Classical growth model focuses on capital
  accumulation in the growth process.
• The more capital an economy has, the faster it
  will grow.
• Because of this emphasis on capital, market
  economies are called capitalist economies.

45
The Classical Growth Model

• Classical economists focused their analysis and
  their policy advice, on how to increase
  investment

• savings Þ investment Þ
• increases in capital Þ growth

46
Focus on Diminishing Marginal Productivity of
Labor

• The Classical growth model focused on how
  diminishing marginal productivity of labor placed
  limitations on growth.
• Farming was the major economic activity and land
  was relatively fixed.

47
Focus on Diminishing Marginal Productivity of
Labor

• Since land was fixed, diminishing marginal
  productivity would set in as population grew.

• As output per person declines, at some point
  available output is no longer sufficient to feed
  the population.

48
Focus on Diminishing Marginal Productivity of
Labor

• This belief is called the iron law of wages.

• The long run was called the stationary state.

49
Diminishing Returns and Population Growth
50
Diminishing Marginal Productivity of Capital

• The predictions of the stationary state turned
  out to be wrong.
• Increases in technology and capital overwhelmed
  the law of diminishing marginal productivity.

51
Diminishing Marginal Productivity of Capital

• The focus then turned to the diminishing marginal
  productivity of capital, not labor

capital grows faster than labor Þ capital is
less productive Þ slower economic output Þ per
capita growth stagnates Þ per capita income
stops rising
52
Diminishing Marginal Productivity of Capital

• Diminishing marginal productivity would be
  stronger for richer nations than for poor ones.

• Poor countries with little capital should grow
  faster than countries with lots of capital.

53
Diminishing Marginal Productivity of Capital

• Eventually per capita incomes among nations would
  converge.

• This has not happened either
• The ambiguity in the definition of inputs.
• Technological progress.

54
Ambiguities in the Definition of the Factors of
Production

• The definition of the factors of production are
  ambiguous.
• It would seem that the definition of labor would
  be straightforward the hours of work that go
  into production.

55
Ambiguities in the Definition of the Factors of
Production

• Economists separate labor into two components.

• Standard labor the actual number of hours
  worked.
• Human capital the skills embedded in workers
  through experience, education, and on-the-job
  training.

56
Ambiguities in the Definition of the Factors of
Production

• Increases in human capital have allowed labor to
  keep pace with capital.

• This allows economies to avoid the diminishing
  productivity of capita.

57
Ambiguities in the Definition of the Factors of
Production

• If skills are increasing faster in a rich country
  than in a poor one, incomes would not be expected
  to converge.

58
Technology

• Technology overwhelms diminishing marginal
  productivity so that growth rates can increase
  over time.

59
Empirical Estimates of Factor Contribution to
Growth

• Economist Edward Denison estimated the importance
  of each of the sources of growth.

60
Sources of Real U.S. GDP Growth, 1928-2000
Human capital (13)
Physical capital (19)
Technology (35)
Labor (33)
61
New Growth Theory

• New growth theory emphasizes the role of
  technology rather than capital in the growth
  process.

62
Technology

• Technology is the result of investment in
  creating technology (research and development).
• Investment in technology increases the
  technological stock of an economy.

63
Technology

• Growth theory separates investment in capital and
  investment in technology.

• Increases in technology are not as directly
  linked to investment as is capital.

64
Technology

• Increases in technology often have enormous
  positive spillover effects.

• Technological advances in one sector of the
  economy lead to advances in completely different
  sectors.

65
Technology

• Technological advances have positive
  externalities.

• Positive externalities positive effects on
  others not taken into account by the decision
  maker.

66
Technology

• Some basic research is protected by patents.

• Patents legal ownership of a technological
  innovation that gives the owner of the patent
  sole rights to its use and distribution for a
  limited time.

67
Technology

• Once people have seen the new technology, they
  figure out sufficiently different way to
  achieving the same end to avoid the patent.

68
Learning by Doing

• New growth theory also highlights learning by
  doing.
• Learning by doing improving the methods of
  production through experience.

69
Learning by Doing

• By increasing the productivity of workers,
  learning by doing overcomes the law of
  diminishing marginal productivity.

70
Increasing Returns to Scale
Production function with increasing returns
71
Technological Lock-In

• Technological lock-in is an example of how
  sometimes the economy does not use the best
  technology available.

72
Technological Lock-In

• Technological lock-in occurs when old
  technologies become entrenched in the market.

• They become locked into new products despite the
  fact that more efficient technologies are
  available.

73
Technological Lock-In

• One reason for technological lock-in is network
  externalities.

• Network externalities an externality in which
  the use of a good by one individual makes that
  technology more valuable to other people.

74
Technological Lock-In

• Switching from a technology exhibiting network
  externalities to a superior technology is
  expensive and sometimes nearly impossible.

75
Economic Policies to Encourage Per Capita Growth

• Encourage saving and investment.
• Control population growth.
• Increase the level of education.
• Create institutions that encourage technological
  innovation.
• Provide funding for basic research.
• Increase the economys openness to trade.

76
Policies to Encourage Saving and Investment

• Modern growth theories have downplayed the
  importance of capital in the growth process.
• However, all agree that it is important.
• Policy makers are eager to encourage both saving
  and investment.

77
Policies to Encourage Saving and Investment

• The U.S. has used tax incentives to increase
  saving.

• Because they dont have much discretionary
  income, it is difficult for poor countries to
  generate saving and investment.

78
A Case Study Micro Credit

• The borrowing circle of Grameen bank is an
  example of how to increase investment in a
  developing nation.
• The traditional way of lending money is to ask
  for collateral.
• In Bangladesh, potential borrowers had no
  collateral.

79
A Case Study Micro Credit

• The bank officer replaced collateral with the
  borrowing circle concept.

• Borrowing circle concept a credit system that
  replaces traditional collateral with guarantees
  by friends of the borrower.
• In case of a default, the friends had to make the
  loan good.

80
Growth Through Foreign Investment

• Foreign investment provides another source of
  saving.
• Developing nations can borrow from the IMF, the
  World Bank, or from private sources.
• None of these are perfect solutions since they
  come with large strings attached.

81
Policies to Control Population Growth

• Developing nations whose populations are rapidly
  growing have difficulty providing enough capital
  and education for everyone.
• Thus, per capita income is low.

82
Policies to Control Population Growth

• Policies that reduce population growth include

• Free familyplanning services.
• Increasing the availability of contraceptives.
• Harsh mandatory one-child-per-family policies
  such as China adopted in 1980.

83
Policies to Control Population Growth

• Some economists argue that to reduce population
  growth, a nation must grow first.

• As income and work opportunities rise, especially
  for women, the opportunity cost of having
  children rises and families will choose to have
  fewer children.

84
Policies to Increase the Level of Education

• Increasing the educational level and skills of
  the workforce increases labor productivity.

85
Policies to Create Institutions That Encourage
Technological Innovation

• Unlike capital, technological innovation can
  occur without investment.
• Conversely, investment in technology can result
  in no technological innovation.

86
Create Patents and Protect Property Rights

• Patents and protecting property rights are two
  ways to encourage innovation.
• Patents are not costless to society.
• Patents allow innovators to charge high prices
  for their use.

87
Create Patents and Protect Property Rights

• Societies must find a middle ground between
  providing incentives to create new technologies
  and allowing everyone to take advantage of the
  benefits of technology.

88
Patents and Developing Countries

• Poor nations are reluctant to enforce U.S.
  patents.
• The U.S. often uses trade policy to attempt to
  force developing countries to do so.

89
The Corporation and Financial Institutions

• Limited liability encourages investors to pool
  their funds.
• Bringing technological innovations to markets
  often requires large amounts of investment over a
  number of years.

90
The Corporation and Financial Institutions

• Well-developed financial institutions such as
  stock markets create liquidity and encourage
  investment.

91
Provide Funding for Basic Research

• Individual firms have little incentive to do
  basic research because of technologys common
  knowledge aspect.
• This is where the government steps in.
• The U.S. government provides 60 percent of the
  basic research in the country.

92
Policies to Increase Openness to Trade

• Free trade increases growth by broadening the
  market and by fostering competition.
• In order to specialize, you need a large market.
• Large markets allow firms to take advantage of
  economies of scale.

93
Growth, Productivity, and the Wealth Of Nations

• End of Chapter 8