© 2 0 1 0 W O R T H P U B L I S H E R S M O D E R N P R I N C I P L E S : M A C R O E C O N O M I C S C O W E N A N D T A B A R R O K
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SEE THE
HAND
Economic growth is a matter of life and death to the 1.8 million children who die of diarrhea each year globally.
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• Key Facts about the Wealth of Nations and
Economic Growth
• Understanding the Wealth of Nations
• Incentives and Institutions
• Takeaway
• Appendix: The Magic of Compound Growth Using a Spreadsheet
• See the Invisible Hand Blog (click) for more examples
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Key Facts about the Wealth of
Nations and Economic Growth
Fact One: GDP per Capita Today Varies Enormously among Nations
Go here to watch a 20 minute TED video about economic growth data.

Key Facts about the Wealth of
Nations and Economic Growth
Wealth and Health go Together.
Source: Penn World Tables and World Bank Group, World Development Indicators, 2005
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Key Facts about the Wealth of
Nations and Economic Growth
Fact Two: Everyone Used to be Poor
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Key Facts about the Wealth of
Nations and Economic Growth
• A Primer on Growth Rates
– How is economic growth measured?
g t
 y t
 y t  1 y t  1
 100
– Where y t is per capita real GDP in year t
– Example:
Year real GDP per capita
2008
2009
$15,000
$15,500 g
2009

15 , 500  15 , 000
 100
15 , 000
 3 .
33 %
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The Rule of 70 (The Magic of
Compounding)
• The rule of 70:
Doubling time 
70 growth rate in %
– Example: If real GDP per capita is growing at an annual growth rate of 3.5%, it will double in:
70
3 .
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 20 years.
– The moral? Small improvements in growth add up fast (the power of compounding).
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A Little Growth Goes a Long Way
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Key Facts about the Wealth of
Nations and Economic Growth
Fact Three: There are Growth Miracles and Growth Disasters
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Understanding the Wealth of Nations
• The Factors of Production are important
– Physical capital: the stock of tools including machines, 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.
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Understanding the Wealth of Nations
• Why do some nations have faster growth than others?
– Besides factors of production, incentives and institutions matter.
• Institutions = “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
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• 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.
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SEE THE
HAND
North and
South
Korea at night
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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, reducing incentives.
– Free riders become a problem.
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• Free Rider = someone who consumes a resources without working or contributing to the resource’s upkeep.
– China’s “Great Leap Forward”- which introduced farming collectives- reduced incentives to work. 20-40 million starved.
– 1978, farmers in Xiaogang met in secret to devise a plan to keep some of their produce.
• Productivity improved so quickly the government allowed the experiment to proceed.
– Food production increased 50% in 5 years 1978-1983.
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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.
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Corruption and Growth
Don’t go Together
Source: Penn World Tables and World Bank Group, World Development Indicators, 2005
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3. Political Stability
• Changing governments without the rule of law creates 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.
Bullet casings from Liberia’s Civil War: Bad soil for anything to grow. 21

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.
– In India, residents who purchase land have to do so more than once because of lack of proper record keeping.
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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.
• 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.
• Click here for Alex Tabarrok’s TED talk about competition and economic growth (15 mins).

• Why do poor countries use their capital inefficiently?
– Whether inadvertently or not, inefficient and unnecessary regulations:
– Create monopolies and impede markets
• Example: until recently in India, it was illegal to produce shirts using large-scale production
• Economies of scale = the advantages of large-scale production that reduce average cost as quantity increases
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Try it!
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• Economic growth
• Physical capital
• Human capital
• Technological knowledge
• Institutions
• Free rider
• Economies of scale
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Try it!
If a nation doubles its GDP per capita in
20 years, what is its annual growth rate?
a) 3.5% b) 4.2% c) 6.5% d) 7%
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Try it!
If a nation doubles its GDP per capita in
20 years, what is its annual growth rate?
a) 3.5% b) 4.2% c) 6.5% d) 7%
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Try it!
What is the most proximate (or direct) cause of growth in real GDP per capita?
a) the factors of production b) political system in the economy c) institutions d) incentives
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Try it!
What is the most proximate (or direct) cause of growth in real GDP per capita?
a) the factors of production b) political system in the economy c) institutions d) incentives
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Try it!
Human capital is the a) stock of tools including machines, structures, and equipment.
b) productive knowledge and skills that workers acquire through education, training, and experience.
c) knowledge about how the world works that is used to produce goods and services.
d) organization skills of business owners.
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Try it!
Human capital is the a) stock of tools including machines, structures, and equipment.
b) productive knowledge and skills that workers acquire through education, training, and experience.
c) knowledge about how the world works that is used to produce goods and services.
d) organization skills of business owners.
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Try it!
Which of the below is not directly related to human capital?
a) a life-saving drug b) schooling c) work experience d) an understanding of chemistry
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Try it!
Which of the below is not directly related to human capital?
a) a life-saving drug b) schooling c) work experience d) an understanding of chemistry
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Try it!
Why did so many Chinese farmers and workers starve under “The Great Leap
Forward”?
a) The number of workers on communes was reduced.
b) The Chinese people did not know how to farm in certain geographic areas.
c) The incentive to work hard was low since the rewards were so minimal.
d) All of the answers are correct.
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Try it!
Why did so many Chinese farmers and workers starve under “The Great Leap
Forward”?
a) The number of workers on communes was reduced.
b) The Chinese people did not know how to farm in certain geographic areas.
c) The incentive to work hard was low since the rewards were so minimal.
d) All of the answers are correct.
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