Modern Principles:
Macroeconomics
Tyler Cowen
and Alex Tabarrok
Chapter 6
The Wealth of Nations
and Economic Growth
Copyright © 2010 Worth Publishers • Modern Principles: Macroeconomics • Cowen/Tabarrok
Introduction
• Every year 1.8 million children die from
•
•
diarrhea.
Preventing these deaths requires only
one thing: economic growth.
Health and wealth go together.
 The next figure shows that the higher the
GDP per capita the greater is the survival
rate of newborns.
Slide 2 of 37
Introduction
Slide 3 of 37
Introduction
• Wealth is clearly important. This leads us
to ask three questions:
 Why are some nations wealthy while others
are poor?
 Why are some nations getting wealthier
faster than others?
 Can anything be done to help poor nations
become wealthy?
• In this chapter and the next, we will try to
answer some of these questions.
Slide 4 of 37
Wealth of Nations and Economic Growth
• Three Key Facts
1. GDP per Capita Today Varies
Enormously among Nations
2. Everyone Used to Be Poor
3. There are Growth Miracles and
Growth Disasters
• Let’s look at each of these in turn.
Slide 5 of 37
Wealth of Nations and Economic Growth
1. GDP per Capita Today Varies Enormously
Among Nations
Slide 6 of 37
Wealth of Nations and Economic Growth
2. Everyone Used to Be Poor
Slide 7 of 37
Wealth of Nations and Economic Growth
• A Primer on Growth Rates
 How is economic growth measured?
y t  y t 1
gt 
 100
y t 1
 Example:
Year
2008
2009
real GDP per capita
$15,000
$15,500
15,50015,000
g 2009 
100  3.33%
15,000
Slide 8 of 37
Wealth of Nations and Economic Growth
• The rule of 70:
70
Doubling time
growth rate in %
 Example: If real GDP per capita is growing at
an annual growth rate of 3.5%, it will double in:
70
 20 years.
3.5
 If the interest rate is expressed in years, the
doubling time will also be in years.
Slide 9 of 37
Wealth of Nations and Economic Growth
•
As the table shows, small changes in
the growth rate → large changes over time.
Slide 10 of 37
Wealth of Nations and Economic Growth
3. Growth Miracles and Growth
Disasters
 The U.S. is one of the wealthiest
countries due to long-run steady
growth.
 Real growth of other countries can
be evaluated by comparing theirs to
the U.S.
Slide 11 of 37
Wealth of Nations and Economic Growth
•
Two Growth Miracles
 Japan:
• annual rate of real growth1950-70 = 8.5%
 South Korea:
• annual rate of real growth1950-70 = 7.2%
•
Two Growth Disasters
 Argentina
• 1900: one of the richest countries in the world
• Now: per capita real GDP is 1/3 that of the U.S.
 Nigeria
• Has barely grown since 1950
• Poorer now than it was in 1974
Slide 12 of 37
Wealth of Nations and Economic Growth
Slide 13 of 37
CHECK YOURSELF
 According to Figure 6.2,approximately
what percentage of the world’s
f
population lived in China in 2000?
 If you make 5 percent on your savings in
a bank account, how many years will it
take for your savings to double? How
about if you make 8 percent?
 In Figure 6.4, approximately when did
Japan’s real GDP per capita cross the
$10,000 barrier? The $20,000 barrier?
What was Japan’s growth rate in that
time span?
Slide 14 of 37
Understanding the Wealth of Nations
• The Factors of Production
 Physical capital: the stock of tools,
structures, and equipment.
 Human capital: is the productive
knowledge and skills that workers acquire
through education, training and
experience.
 Technological knowledge: knowledge
about how the world works that is used to
produce goods and services.
Slide 15 of 37
CHECK YOURSELF
 Which country has more
physical capital: the United
States or China? China or
Nigeria?
 What are the three primary
factors of production?
Slide 16 of 37
Incentives and Institutions
• The amount of available resources only
tells part of the story.
 Why do some countries have more physical
and human capital and use more advanced
technology?
 Why do some countries obtain greater
output from the resources they have than
others?
 The answers lie in the institutions and
incentives that countries adopt.
Slide 17 of 37
Incentives and Institutions
•
•
A natural experiment - North and South Korea
 Before division after WWII
• Shared the same people and culture.
• Had similar levels of physical capital.
• Had access to the same technology.
 North Korea became a communist state with a
centrally planned economy.
 South Korea adopted the capitalist free market
model.
The result 50 years later is dramatic as seen in the
following photo from outer space.
Slide 18 of 37
Incentives and Institutions
North and South Korea at Night
Slide 19 of 37
Incentives and Institutions
• Institutions are the “rules of the game”
•
that structure economic incentives.
Institutions of Economic Growth
1. Property rights
2. Honest government
3. Political stability
4. A dependable legal system
5. Competitive and open markets
Slide 20 of 37
Incentives and Institutions
• Institutions of Economic Growth (cont.)
1. Property rights: the right to benefit from one’s
effort.
• Provide incentives to work hard.
• Encourage investment in physical and
human capital.
• Are important for encouraging technological
innovation.
• Without property rights:
 Effort is divorced from payment →
↓incentive to work
 Free riders become a problem
Slide 21 of 37
Incentives and Institutions
• Institutions of Economic Growth (cont.)
2. Honest Government
• Property rights are meaningless unless
government guarantees property rights.
• Corruption bleeds resources away from
productive entrepreneurs.
• Corruption takes resources away from more
productive government activity.
• Next is a list of the 10 most and the 10 least
corrupt countries. Are you surprised to see
who is or who isn’t on these lists?
Slide 22 of 37
Honest Government: The Good and the Bad
Slide 23 of 37
Honest Government: The Good and the Bad
Slide 24 of 37
Incentives and Institutions
• Institutions of Economic Growth (cont.)
3. Political Stability
• Changing governments without the rule of
law results in uncertainty which leads to
less investment in physical and human
capital.
• In many nations civil war, military
dictatorship, and anarchy have destroyed
the institutions necessary for economic
growth.
Slide 25 of 37
Incentives and Institutions
• Institutions of Economic Growth (cont.)
4. Dependable Legal System
• A good legal system facilitates contracts and
protects property from others including
government.
• Poorly protected property rights can result from
too much government or too little government.
 The legal system in some governments is
so poor that no one knows who owns what.
Example: In India, residents who purchase
land have to do so more than once because
of lack of proper record keeping.
Slide 26 of 37
Incentives and Institutions
• Institutions of Economic Growth (cont.)
5. Competitive and Open Markets
• Encourage the efficient organization of
resources.
• About half the differences in per capita
income across countries is explained by a
failure to use capital efficiently.
• Example: One study found that if India used
its physical and human capital as efficiently
as the U.S., India would be four times richer
than it is today.
Slide 27 of 37
Incentives and Institutions
• Institutions of Economic Growth (cont.)
 Why do poor countries use their capital
inefficiently?
• Inefficient and unnecessary regulations
Create monopolies
Impede markets
• Example: until recently in India, it was
illegal to produce shirts using largescale production
• Expensive red tape increases time and cost
Slide 28 of 37
Incentives and Institutions
• Institutions and Growth Revisited
 Economic growth would become more common
if more countries changed their institutions.
 Where do institutions come from?
• Culture?
• History?
• Geography?
• Luck?
 Key research question in economics:
Understanding institutions, where they come
from and how they can be changed.
Slide 29 of 37
CHECK YOURSELF
 List five institutions that promote economic
growth.
 In England during the Wars of the Roses (late
1400s), two parties fought for the crown.
Contrast the prospects for economic growth
during this period and after this period when
Henry VII became the unquestioned head of the
country.
 When the Pilgrims landed at Plymouth Rock,
they established a system of collective farming
in which all corn production was shared. Given
your understanding of incentives, what do you
think happened to the Pilgrims?
Slide 30 of 37
Takeaway
• Economic growth has resulted in GDP
•
•
•
per capita today being 50 times higher in
the rich countries than in the poorest.
Economic growth has lifted billions out of
near-starvation poverty but billions still
remain in dire poverty.
Poor countries can catch up to the rich
countries in a surprisingly short period of
time.
Accumulation of human and physical
capital is key but not sufficient.
Slide 31 of 37
Takeaway
• Countries with institutions that encourage
the efficient use of human and physical
capital will succeed.
 These institutions are:
• Property rights
• Honest Government
• Political stability
• Dependable legal system
• Competitive and open markets.
Slide 32 of 37
Modern Principles:
Macroeconomics
Tyler Cowen
and Alex Tabarrok
Chapter 6 Appendix:
The Magic of Compound Growth
Using a Spreadsheet
Copyright © 2010 Worth Publishers • Modern Principles: Macroeconomics • Cowen/Tabarrok
Appendix
•
•
The rule of 70 is handy, but using a Microsoft
Excel spreadsheet can help answer more difficult
questions.
Compound Growth: The Long Method
Slide 34 of 37
Appendix
•
Compound Growth: The Shortcut
If the growth rate is r percent and we grow for n
years then:
n
r


Ending Value  Starting Value  1 

 100 
Slide 35 of 37
Appendix
•
Use Excel’s Goal Seek to work backward to find,
for example: number of years to reach a certain
level of GDP.
 The ending value in cell B6 is fixed at
1,000,000. Excel then calculates the value of
the variable in B2, that will give this result.
Slide 36 of 37
Appendix
•
The problem is solved
 Starting with $46,000 and growing at a rate of
2%, it will take a little over 150 years to reach
$1,000,000.
Slide 37 of 37