Questions
• What is modern economic growth?
• What was the post-1973 productivity
slowdown?
CHAPTER 5
The Reality of Economic Growth:
History and Prospect
5-1
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– What were its causes?
– When did it end?
• Why are some nations so (relatively)
rich and other nations so (relatively)
poor?
5-2
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Questions
Before the Industrial Revolution
• What policies can speed up economic
growth?
• What policy mistakes can slow down
economic growth?
• What are the prospects for successful
and rapid economic development in
tomorrow’s world?
• Up until 1500, there had been almost
zero growth of output per worker
• After 1800, we see large sustained
increases in worldwide standards of
living
5-3
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Table 5.1 - Economic Growth through Deep
Time
Year
5-5
Population (millions)
– population growth accelerated
– output per capita grew
5-4
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Figure 5.1 - World Population Growth since 1000
Real GDP per Capita
5000 BC
5
$ 130
1000 BC
50
160
1 AD
170
135
1000
265
165
1500
425
175
1800
900
250
1900
1,625
850
1950
2,515
2,030
1975
4,080
4,640
2000
6,120
8,175
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5-6
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1
Premodern Economies
• There are two principal reasons that
there were no sustained increases in
the productivity of labor before 1500
– resource scarcity
– expanding populations
Premodern Economies
• Remember that Y/L depends on two
factors
– the economy’s capital intensity (K/Y)
– the efficiency of labor (E)
• The level of Y/L is therefore
!
Yt ( K t % 1"!
= & # (E t )
L t &' Yt #$
5-7
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5-8
Premodern Economies
• Also remember that, in the long run,
K/Y tends to approach an equilibrium
Premodern Economies
• Natural resources played an
important role
– sustained growth must be driven by
sustained increases in the efficiency of
labor
– as populations grew, the stocks of
natural resources had to be divided
among more and more people
– increases in technological capability
induce increases in fertility that
inevitably run into natural-resource
scarcity
• If productivity does not grow, it must
be because labor efficiency did not
grow
5-9
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5-10
– first academic professor of economics
– introduced the idea that increases in
technology inevitably run into natural
resource scarcity
• We no longer live in a Malthusian
age
– for at least 200 years, new technologies
and better organizations have made
improvements in the efficiency of labor
possible
– these improvements have not been
neutralized by natural-resource scarcity
• implies that increases in technology lead to
an increase in the size of the population but
not to an increase in the standard of living
5-11
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The End of the
Malthusian Age
Premodern Economies
• Thomas R. Malthus
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5-12
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2
The End of the
Malthusian Age
• However, a Malthusian age may
return
The End of the
Malthusian Age
• It is likely that the population
explosion is almost over
– suppose that the population in the 21st
and 22nd centuries grows at the same
rate it did in the 20th century (1.33%)
– the United Nations predicts that the
world population will grow from over 6
billion today to around 10 billion by 2050
• the population will double in 72/1.33 = 54
years
– after that, the population increase may
stop as birth rates have been on the
decline around the world
• In 200 years, there would be nearly 90
billion people on earth
5-13
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5-14
The End of the
Malthusian Age
• What caused the end of the
Malthusian age?
– the pace at which inventions occurred
increased steadily
The Demographic Transition
• As material standards of living rise
far above subsistence, countries
undergo a demographic transition
– birth rates rise
– death rates fall
– birth rates fall
– by about 1500, technological progress
passed the point at which it could offset
increased scarcity of natural resources
due to population growth
5-15
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5-16
Figure 5.2 - Stylized Picture of the
Demographic Transition
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The Demographic Transition
• In the world today, not all countries
have gone through their demographic
transitions
– Nigeria, Iraq, Pakistan, and the Congo
are projected to have population growth
rates greater than 2% per year over the
next generation
5-17
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5-18
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3
Figure 5.3 - Expected Population Growth
Rates, Present-2020
5-19
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Figure 5.3 - Expected Population Growth
Rates, 1997-2015
5-20
The Industrial Revolution
• The industrial revolution began the
era of modern economic growth
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The Industrial Revolution
• The new technologies were not
confined to Great Britain
– new technological leaps revolutionized
industries and generated major
improvements in living standards
– they spread rapidly to western Europe
and the United States
– they spread less rapidly to southern and
eastern Europe and Japan
• Great Britain was the center of the
industrial revolution
– English became the world’s de facto
second language
5-21
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5-22
Figure 5.4 - Industrialized Areas of the
World, 1870
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The Industrial Revolution
• Why did the Industrial Revolution
take place in Great Britain and why
did it occur around 1800?
– the establishment of limited
government, security of property, and
freedom of contract in Great Britain after
the Glorious Revolution of 1688
– the creation of modern science and the
technological tradition of sustained
inquiry into how the world worked
5-23
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5-24
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4
American Long-Run Growth,
1800-1973
• Growth in the second half of the 19th
century was faster than it had been
in the first half
• Growth accelerated further in the
early part of the 20th century
American Long-Run Growth,
1800-1973
• During the late 19th century, the
capital-output ratio increased greatly
– the creation of railroads generated the
possibility of supplying an entire
continental market from a single factory
– this encouraged investment by
entrepreneurs
– a second wave of industrialization
occurred from new inventions and
innovations
5-25
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5-26
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Figure 5.5 - U.S. Measured Economic
Growth: Real GDP per Worker 1995 Prices,
1890-2004
American Long-Run Growth,
1800-1973
• Growth slowed slightly during the
Great Depression and World War II
– 1.4 percent per year from 1929 to 1950
• Growth accelerated from 1950 to
1973 (2.1 percent)
5-27
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5-28
American Long-Run Growth,
1800-1973
• Next to none of the growth since
1929 was the result of increases in
K/Y
– almost all of it was the result of
increases in the efficiency of labor
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American Long-Run Growth,
1800-1973
• Many economists believe that official
estimates of output per worker
overstate inflation and understate
real economic growth by 1 percent
per year
– national income accountants have a hard
time valuing the boost to productivity
and standards of living generated by
new inventions
5-29
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5-30
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5
American Long-Run Growth,
1800-1973
Table 5.2 – Labor-Time Costs of
Commodities, 1895-1997
• Structural changes also occurred
– a large drop in the proportion of the
labor force working as farmers occurred
– new methods of travel were developed
– a large number of innovative
technologies and business practices were
adopted
5-31
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5-32
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American Long-Run Growth,
1800-1973
American Economic Growth
Since 1973
• The U.S. became the world’s leader
(in terms of technology) during the
20th century because
• Between 1973 and 1995 measured
output per worker grew at only 0.6
percent per year
– the U.S. had an exceptional commitment
to education
– the U.S. was the largest market in the
world
– the U.S. was extraordinarily rich in
natural resources
– the U.S. avoided fratricide
5-33
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– between 1950 and 1973, labor
productivity growth had been 2.1
percent per year
• The other major industrial economies
in western Europe, Japan and Canada
also experienced a slowdown in
productivity
5-34
Table 5.3 - The Magnitude of the Post-1973
Productivity Growth Slowdown in the G-7
Economies
Output-per-Worker Annual Growth (%)
Country
1950-1973
1973-1995
United States
2.1
0.6
Canada
2.7
1.6
Japan
7.4
2.6
Britain
2.4
1.8
Germany (West)
5.7
2.0
France
4.4
1.5
Italy
4.9
2.3
5-35
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American Economic Growth
Since 1973
• Suggested causes of the productivity
slowdown include
– environmental protection measures
– increased problems of economic
measurement
– the baby boom generation
– the tripling of world oil prices in 1973
• The actual cause of the productivity
slowdown remains a mystery
5-36
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6
Effects of the Productivity
Growth Slowdown
Figure 5.6 - Measured Real Mean Household
Income, by Quintile
• Slower economic growth has made
Americans feel much less well off
than they had expected that they
would be
– for some workers, the post-1973
productivity slowdown has been
accompanied by stagnant or declining
real wages
– increased income inequality has also
occurred
5-37
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5-38
Productivity Growth Speedup:
The New Economy
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Figure 5.7 – Two-Year Growth Rates in
Labor Productivity
• Since 1995, productivity growth in
the U.S. has accelerated
– during the second half of the 1990s it
was 2.1 percent per year
– in the first half of the 2000s, it is 3.8
percent per year
5-39
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5-40
Productivity Growth Speedup:
The New Economy
• Investment began rising in 1992
– business fixed investment grew at
almost three times the rate of GDP
• much of the additional investment has gone
to purchase computers and related equipment
• The recent acceleration in
productivity growth was due to this
boom in real investment
5-41
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Productivity Growth Speedup:
The New Economy
• Productivity growth continued to be
quite rapid during the short recession
of 2001, the uneven recovery of 2002,
and the faster recovery periods of
2003 and 2004
– generally productivity growth slows
during a recession
– but business used investment in hightech equipment to continue to boost
worker productivity during 2001
5-42
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7
Modern Economic Growth
around the World
Figure 5.8 - World Distribution of Income
Today, Selected Countries
• The industrial core of the world
economy experienced a large
increase in its level of material
productivity and living standards
during the 19th and 20th centuries
• Elsewhere the growth of productivity
levels and living standards was slower
• The world has become a more and
more unequal place
5-43
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5-44
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Modern Economic Growth
around the World
Figure 5.8 - World Distribution of Income
Today, Selected Countries
• The U.S. has not been the fastestgrowing economy in the world
– a number of other countries at different
levels of industrialization, development,
and material productivity a century ago
have now converged
– their current levels of productivity,
economic structures, and standards of
living are very close to those of the U.S.
5-45
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5-46
Figure 5.9 - Convergence among the G-7
Economies: Output per Capita as a Share
of U.S. Level
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Modern Economic Growth
around the World
• By and large, the economies that
have converged belong to the
Organization for Economic
Cooperation and Development
(OECD)
– group of countries that gave or received
aid under the Marshall Plan to help
rebuild or reconstruct after World War II
5-47
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5-48
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8
Modern Economic Growth
around the World
• The OECD countries adopted a
common set of economic policies
– large private sectors free of government
regulation of prices
– investment with its direction determined
by profit-seeking businesses
– large social insurance systems to
redistribute income
– governments committed to avoiding
mass unemployment
5-49
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Modern Economic Growth
around the World
• The OECD countries ended up with
mixed economies
– markets direct the flow of resources
– governments stabilize the economy,
provide social-insurance safety nets, and
encourage entrepreneurship and
enterprise
5-50
Modern Economic Growth
around the World
• As the OECD countries became
richer, they completed their
demographic transitions
• The policy emphasis on free
enterprise boosted investment
• Equilibrium capital-output ratios rose
• Diffusion of technology from the U.S.
occurred
5-51
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Modern Economic Growth
around the World
• Economic growth has not been
limited to OECD countries
– since World War II, several countries in
east Asia have experienced stronger
growth than has ever been seen
anywhere in world history
– these successful east Asian countries are
somewhat similar to the OECD
economies in terms of economic policy
and structure
5-52
Modern Economic Growth
around the World
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Table 5.4 - The Iron Curtain: GDP-perCapita Levels of Matched Pairs of Countries
• Many countries have not been so
fortunate
• Countries that have been ruled by
communists in the 20th century have
remained poor
5-53
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5-54
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9
Modern Economic Growth
around the World
Modern Economic Growth
around the World
• Individuals living in countries outside
of the Iron Curtain have higher levels
of GDP-per-capita
• Even if attention is confined to
noncommunist-ruled economies,
there has still been enormous
divergence in relative output-perworker levels over the past 100 years
– they may not have better education,
health care, or a more favorable income
distribution
5-55
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5-56
Sources of Divergence
• The principal cause of the large
variation in output per worker
between countries today are
differences in their equilibrium capitaloutput ratios
Sources of Divergence
• Two secondary causes of the large
variation in output per worker
between countries today are
– openness to creating and adapting the
technologies that enhance the efficiency
of labor
– the level of education today
– K/Y is determined by
• the level of investment
• the growth rate of the labor force
5-57
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5-58
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Cause and Effect,
Effect and Cause
Figure 5.10 - GDP-per-Worker Levels and
Average Years of Schooling
• High population growth and low
output per worker go together
– rapid population growth reduces the
equilibrium capital-output ratio
– poor countries have not undergone their
demographic transitions
5-59
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5-60
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10
Cause and Effect,
Effect and Cause
• Other vicious circles can occur
– poor countries will have a high relative
price for capital equipment
Hopes for Convergence
• The context of economic “stagnation”
and “failure” are relative terms
– net national product in Argentina is
about three times what it was in 1900
– net national product in Norway is about
nine times what it was in 1900
• this implies that poor countries get less
investment out of any given effort at saving
– good education is harder to provide in
poor countries
• Setting the demographic transition in
motion will offset these problems
5-61
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• The world’s industrial leaders provide
a benchmark of how much better
things could have been
5-62
Policies for Saving,
Investment, and Education
Hopes for Convergence
• Differences in productivity and living
standards between national
economies should be eroded over
time due to
• Policies to boost saving include
– ensuring that savers get a reasonable
rate of return on their savings
– minimizing restrictions on
entrepreneurship
– keeping inflation low
– keeping government deficits to a
minimum
– world trade
– migration
– flows of capital
– developing countries entering the
demographic transition
5-63
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5-64
Policies for Saving,
Investment, and Education
• Policies to boost investment for a
given level of savings include
– welcoming money from foreign investors
– allowing businesses to freely earn and
spend foreign exchange
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Policies for Saving,
Investment, and Education
• Promoting universal access to
education can provide two important
benefits
– a better-educated workforce is likely to
be more productive
– educated women will likely pursue
opportunities outside the home
• reducing tariffs and quotas
• subsidizing investment and expansion by
businesses that successfully compete in
world markets
5-65
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• the birth rate will likely fall
• the demographic transition will occur more
quickly
5-66
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11
Policies for Technological
Advance
• Technological progress has two
components
– science
– research and development
• amounts to 3 percent of GDP in the U.S. and
other industrial economies
5-67
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Policies for Technological
Advance
• Governments seeking to establish
patent laws face a dilemma
– if the patent laws are strong, much of
the modern technology in the economy
will be restricted in use
– if the patent laws are weak, profits that
innovators and inventors can earn will be
low
Policies for Technological
Advance
• Businesses conduct investments in
research and development to
increase profit
• Research and development is a public
good
– other firms can copy it
– patents limit the ability of other firms to
do so
5-68
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Government Failure
• The broad experience of growth in
developing countries (with the
exception of east Asian and OECD
countries) has been that
governments often will not create
policies that assist in growth and
development
• pace of technological improvement will slow
5-69
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5-70
Government Failure
• Typical systems of regulation in
developing countries have retarded
development by
– “prestige” industrialization programs
– inducing firms and entrepreneurs to
devote their energies to seeking rents
– creating systems of regulation and
project approval that have become
extortion machines for manufacturing
bribes for the bureaucrats
5-71
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Government Failure
• Neoliberalism describes much of
the recent thinking about the proper
role of government in economic
growth
– the government has a sphere of core
competencies at which it is effective
• administration of justice, maintenance of
macroeconomic stability, provision of social
insurance, some infrastructure development
5-72
– governments should limit role to their
core competencies
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12
Chapter Summary
• Back before the commercial
revolution (before 1500 or so),
economic was very slow
Chapter Summary
• The way out of the Malthusian trap
opened about 1500
– populations grew
– standards of living grew
– levels of material productivity grew
– populations grew at a glacial pace
– there were no significant increases in
standards of living for millennia before
1500
– humanity was caught in a Malthusian trap
5-73
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5-74
Chapter Summary
• The Industrial Revolution was the
start of the current epoch: the epoch
of modern growth
Chapter Summary
• Modern economic growth is welldescribed by the standard growth
model
– starting in the mid-18th century, the
pace of invention and innovation
increased
– output per worker and capital per worker
increase at a pace measured in percent
per year
• key inventions replaced muscle with machine
power
• material productivity levels boomed
5-75
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• the pace has been extraordinarily rapid in
long-term historical perspective
5-76
Chapter Summary
• Productivity growth rates slowed
down worldwide after 1973, causing
living standards to rise more slowly in
the 1970s and 1980s
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Chapter Summary
• Productivity growth rates sped up
after 1995 and continue at this
higher pace
– the acceleration was due to a boom in
real investment in computers and
related equipment
– several explanations have been offered
for this productivity growth slowdown,
but economists generally agree the
causes remain a mystery
5-77
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5-78
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13
Chapter Summary
• Looking across nations, the world is
an astonishingly unequal place in
relative terms
– the relative gap between rich and poor
nations in material productivity is much
greater than it has ever been before
5-79
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Chapter Summary
• Combining the determinants of the
balanced-growth capital-output ratio
with the proximate determinants (the
level of technological knowledge and
average educational attainment in a
country after World War II) accounts
for most of the variation in the
relative wealth and poverty of nations
today
5-80
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Chapter Summary
• Macro policies to increase economic
growth are policies to
– accelerate the demographic transition
(through education)
– increase savings rates
– boost the amount of real investment a
country gets for a given saving rate
– increase the rate of invention or
technology transfer
5-81
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14