Economics 285
Economic
Growth
I.B.M. Will Invest
$5 Billion To
Produce Newer
Microchips
– NY Times 10/10/2000
1
Economic Growth
 Long-Term
Growth Trends
 The Sources of Economic Growth
 Growth Accounting
 Growth Theory
 Achieving Faster Growth
2
Long-Term Growth Trends
 Long-term
growth trends are the trends in
potential GDP
3
A Hundred Years of Economic
Growth in the United States
4
Economic Growth in Canada
Figure shows
long-term growth
in Canada since
1895.
Growth was
fastest during
the 1960s.
5
Long-Term Growth Trends
 Fig.
11.2(a)
shows growth
in the biggest
economies
since 1960.
 Japan has
caught up with
the other big
economies.
6
Long-Term Growth Trends
 Fig.
11.2(b)
shows gaps
in real GDP
per person
have been
very
persistent for
most groups
of countries.
8
Long-Term Growth Trends
 Fig.
11.3 shows some Asian economies
closing the gap in real GDP per person.
9
The Sources of Economic
Growth
 Economic
growth occurs when
incentives are created by:



10
markets
property rights
monetary exchange
The Sources of Economic
Growth
 The
activities that generate growth
are:



11
saving and investment
growth of human capital
discovery of new technologies
Growth Accounting
 Growth
accounting is the attempt
to measure the contributions to
growth of labor, capital, and
technological change.
 Real GDP growth equals the growth
of real GDP per hour of work plus
the growth rate of aggregate hours.
12
Growth Accounting
 The
growth rate of real GDP per
hour of work depends on:


Growth of capital per hour of labor
Technological change
 Fig
11.4 is a time series plot of
GDP per hour of work for US
13
Real GDP per Hour of Work
14
Fig 11.4 -- time series plot of GDP per hour of work for US
Productivity function
 Separates


the effects of:
Growth of capital per hour of labor
Technological change
 Hold
technology constant, vary
capital per hour of work
15
Real GDP per hour of work (1992 dollars)
How Productivity Grows
17
PF0
32
PF0
25
Effect of
technological
change
20
Effect of
increase
in capital
stock
0
30
60
Capital per hour of work (1992 dollars)
Fig. 11.5
Growth Accounting
 One-third
rule.
Goal: Divide the
increase in real
GDP per hour of
work into


capital effect
technological
change effect
18
Growth Accounting
 An
x percent
increase in
capital per hour
of work brings
a 1/3 of x
percent
increase in
output per hour
of work.
20
Growth Accounting
 The
remaining
increase in
output per hour
of work is
attributed to
technological
change (and
unidentified
factors).
21
Growth Accounting
 Growth
accounting is used to
account for the productivity
growth slowdown.
 Figure 11.6 shows how this type of
breakdown is made.
22
Growth Accounting and the
Productivity Growth Slowdown
23
Growth Accounting
Technological Change During the
Productivity Growth Slowdown
Technology was directed toward coping
with two major problems.
1) Energy price shocks
2) The environment
27
Growth Accounting
Achieving Faster Growth





30
Stimulate Saving
Encourage international trade
Improve the quality of education
Stimulate high-technology industries?
Target high-technology industries?
Growth Theory
 The
task of growth theory is to
explain the trends in economic
growth.
 Three main theories have been
proposed:



31
Classical growth theory
Neoclassical growth theory
New growth theory
Classical Growth Theory
Real GDP growth is temporary




33
Real GDP per person above subsistence
Brings population explosion
Returns real GDP per person back to the
subsistence level.
Malthusian theory.
Classical Growth Theory
The Basic Idea (1776)




34
Real GDP has increased
Real wage rate has increased
Population growth increases labor supply
Wage falls due to diminishing returns...
... to labor
Classical Growth Theory
Subsistence real wage rate


35
Minimum needed to maintain life.
If the real wage rate falls below
subsistence, some people cannot survive
and population growth subsides
Real wage rate (1776 shillings per day)
Growth Begins
New technologies and
more capital increase
the productivity of labor
4
3
2
1
0
36
LS0
5
LD1
LD0
1
2
3
4
5
6
Labor (millions)
Real wage rate (1776 shillings per day)
A Dismal Outcome
LS1
When the real wage
rate exceeds the
subsistence level, the
population increases
4
3
Subsistence
real wage rate
2
LD1
1
0
37
LS0
5
1
2
3
4
5
6
Labor (millions)
Modern Theory of
Population Growth
 Income
levels and population growth
may be inversely related



Opposite of Malthus
Income  death rate falls
Income  birth rate falls
 Relationship
38
is weak
Neoclassical Growth Theory
 Technological
40
change

Induces saving and investment

Makes capital per person grow
Neoclassical Growth Theory
The Basic Idea





42
Technological advances promise new profit
opportunities
ID increases, real interest rate rises
Saving increases
K stock grows
Real GDP and YD grow
Neoclassical Growth Theory
The Basic Idea (cont.)


43
Prosperity will persist
Growth will stop if technology stops
advancing:
• profit leads to K accumulation
• diminishing returns to capital
Neoclassical Growth Theory
Target Rate and Long-Run Saving



44
When real interest rate exceeds the target
rate, the K stock increases
When the target rate exceeds real interest
rate, the K stock decreases
When real interest rate = the target rate,
the K stock is constant
Neoclassical Growth Theory
Target Rate and Long-Run Saving (cont.)



45
Technology advances, real GDP grows but
the growth rate diminishes
New advances increase the demand for
capital, raising the real interest rate and
inducing saving
Rate of technological progress is
unpredictable
Neoclassical Growth Theory
Target Rate and Long-Run Saving (cont.)

46
The process repeats as long as technology
advances, creating an on-going process of
long-term economic growth.
Neoclassical Growth Theory
A contradicted hypothesis?



47
Technology and capital are mobile
Therefore growth rates and per-capita
income levels converge
Data reveal that convergence is slow or
absent
Why?
Real interest rate (percent per year)
Neoclassical Growth Begins
10
Technological
advances increase
investment
demand...
SS0
8
…real interest
rate, saving, and
investment increase
6
4
2
ID0
0
48
0.5
1.0
1.5
2.0
ID1
2.5
Savings and investment (trillions of 1992 dollars)
Neoclassical Growth Ends
Real interest rate (percent per year)
KS0
10
When the real interest
rate exceeds the target
rate, saving and
investment increase the
supply of capital.
8
6
b
a
4
2
0
49
KS1
KD0
5
10
15
20
LKS
KD1
25
Capital stock (trillions of 1992 dollars)
New Growth Theory
Holds that real GDP per person grows
because of the choices that people
make in the pursuit of profit and that
growth can persist indefinitely.
50
New Growth Theory
New growth theory begins with two facts
about market economies:
1) Discoveries result from choices.
2) Discoveries bring profit, and
competition destroys profit.
51
New Growth Theory
Discoveries and Choices


52
The pace of discoveries is not determined
by chance.
It depends on how many people are
looking for a new technology and how
intensively they are looking.
New Growth Theory
Two other facts are key to new growth
theory:
1) Discoveries can be used by many
people at the same time.
2) Physical activities can be replicated.
54
New Growth Theory
Real interest rate (percent per year)
KS0 KS1
KS3
10
8
6
KD1
4
LKS
a
KD0
2
0
57
KS2
1
2
3
4
5
Capital (trillions of 1992 dollars)