© 2007 Thomson South-Western
Table 1.1
Table 1 The Variety of Growth Experiences
Turkey’s Growth:
According to data from Penn World Tables,
Turkey’s real GDP in 1950 was $1543, in
2004 was $5982 (in 2000 dollars).
 Turkey’s real GDP grew at an annual
average growth rate of 5.3 percent
between 1950 and 2004. This puts Turkey
in the “growth miracles” group with Hong
Kong and Singapore. If the same growth
continues, the economy will double every
13 years (log(2)/log(1.053)).

Production and Growth
How can we explain differences in levels
of income and growth rates of income
across countries?
 Levels: Why are some countries rich now
(Japan, Western Europe, US) and others
are poor now?
 Growth Rates: Why are some countries
growing fast (India, China, South Korea)
and others are not growing at all (African
countries)?

Production and Growth


Productivity is the
amount of goods and
services that an
average worker
produces in one hour.
A country’s standard
of living is determined
largely by the
productivity of its
workers.
Productivity: Its Role and Determinants

Why Productivity Is So Important


Productivity determines living standards for all
nations in the world.
To understand the large differences in living
standards across countries, we must focus on
the production of goods and services.
How Productivity Is Determined
What determines productivity? The factors
of production determines productivity.
 The inputs used to produce goods and
services are called the factors of
production.
 The factors of production include:





Physical capital (machinery, equipment,
buildings)
Human capital (education, training,
experience)
Natural resources (Land, natural gas, oil, etc.)
Technological knowledge (expertise)
How Productivity Is Determined
Physical capital is the stock of machinery,
equipment and infrastructure that are
used to produce goods and services.
 Physical capital includes:





Machines used to manufacture automobiles, furniture,
other machines (lathe), etc.
Construction: Office buildings, schools, etc.
Infrastructure: Roads, electricity and telecommunication
networks.
Physical capital is a produced factor of
production.

It is both an input into the production process and an
output from the production process.
How Productivity Is Determined
Human capital is the knowledge and
skills that workers acquire through
education, training, and experience.
 Like physical capital, human capital raises
amount of goods and services that one
worker can produce.

How Productivity Is Determined

Natural resources are inputs used in
production that are provided by nature,
such as arable land, seaports, rivers, oil,
natural gas, copper, iron etc.



Renewable resources include trees and forests.
Nonrenewable resources include petroleum, gas, coal.
Natural resources are important but are
not absolutely necessary for an economy
to be highly productive. Consider Japan.
Imports many raw materials and energy.
How Productivity Is Determined

Technological knowledge includes society’s
understanding of the best methods to
produce goods and services. Two types:



Common knowledge (math, assembly line, tractors)
Patented knowledge (BMW engine design, Coca-cola
formula, Intel core duo processor, etc.)
Consider farming technology in 1970 and
2004. 71% of Turkey’s population were
working in farming sector in 1970. In
2004, only 40% was working in farming.
Use of tractors, fertilizers, etc. increased
productivity in the sector.
The Production Function

Economists often use a production
function to describe the relationship
between the quantity of inputs used in
production and the quantity of output.
The Production Function

Y = A F(L, K, H, N)







Y = quantity of output
A = level of technology
L = quantity of labor (number of workers or
hours)
K = quantity of physical capital
H = quantity of human capital
N = quantity of natural resources
F( ) is a function that shows how the inputs
are combined.
The Production Function

A production function has constant
returns to scale if, for any positive
number x,

xY = A F(xL, xK, xH, xN)
That is, if we double all inputs (if x = 2),
then the amount of output doubles too.
 If xY < (>) A F(xL, xK, xH, xN) then there
is increasing (decreasing) returns to scale.

The Production Function
Production functions with constant returns
to scale property can be written in ‘per
worker’ terms.
 Setting x = 1/L,



Y/L = A F(1, K/L, H/L, N/L)
Where:




Y/L = output (GDP) per worker
K/L = physical capital per worker
H/L = human capital per worker
N/L = natural resources per worker
The Production Function

Then Productivity (Output per worker, Y/L)
depends on:




physical capital per worker (K/L),
human capital per worker (H/L),
natural resources per worker (N/L),
and the level of technology (A).
Economic Growth And Public Policy

Government policies that raise
productivity and living standards






Encourage saving and investment. (Increase K) Asian
economies have high saving rates.
Encourage investment from abroad (two types: FDI and
FPI, which one is better?).
Encourage education and training (Increase H).
Establish secure property rights and maintain political
stability. Decrease uncertainty about future.
Promote free trade.
Promote research and development to improve
technology.
Saving and Investment

One way to raise future productivity is to invest more
current resources in the production of physical capital
(machines, infrastructure: roads, telecommunication, etc.).
But for this we need to consume less now and save more.
Saving and Investment Rates are important. Turkey’s
saving rate = 19%, investment rate: 25% in 2005.
Diminishing Marginal Returns and the
Convergence Effect
As the stock of capital rises, the extra
output produced from an additional unit of
capital falls; this property is called
diminishing marginal returns of capital.
 Because of diminishing marginal returns,
an increase in the saving rate leads to
higher growth only for a while.
 In the long run, the higher saving rate
leads to a higher level of productivity and
income, but not to higher growth rate in
these areas.

Illustrating the Production Function
Output
per worker
1
2. When the economy has a
high level of capital, an
extra unit of capital leads to
a small increase in output.
1. When the economy has a low level of capital, an
extra unit of capital leads to a large increase in output.
1
Capital per
worker
© 2007 Thomson South-Western
Diminishing Marginal Returns and
the Convergence Effect

The convergence (catch-up) effect is a
property where countries that start off
poor tend to grow more rapidly than
countries that start off rich.
Investment from Abroad
Governments can increase capital
accumulation and long-term economic
growth by encouraging investment from
foreign sources. Turkey received 6% Net
Capital Inflows in 2005.
 S = 19%, I = S + NCI = 25%.

Investment from Abroad
 Investment
forms:

Foreign Direct Investment


from abroad takes two
Capital investment owned and operated by a foreign
firm. It can also be a partnership with a Turkish firm.
Ex: Toyota plant in Kocaeli.
Foreign Portfolio Investment

Investments financed with foreign money but
operated by domestic residents. Ex: German
residents buy Akbank stocks at ISE.
Investment from Abroad




Why FDI is low in Turkey:
Labor Market: In Turkey, severance pay (cost
of firing), social security premium,
unemployment insurance premium and taxes
are high. Thus domestic and foreign investors
escape Turkey to other low-cost countries like
Ukraine, China, Romania, Poland etc.
There is political instability in Turkey.
Labor force is not educated- low human
capital.
Education
For a country’s long-run growth, education
is at least as important as investment in
physical capital.
 In the United States, each year of
schooling raises a person’s wage, on
average, by about 10 percent.
 Thus, the government can increase the
standard of living by support schools. But
strategically accroding to the needs of the
economy.

Education
The social benefit of society from an
educated person might be larger than his
private benefit from education. He
provides an external benefit to others.
This is called a positive externality.
 One problem facing some poor countries is
the brain drain — the emigration of many
of the most highly educated workers to
rich countries. Why do they emigrate?
How can we reverse brain drain?

Property Rights and Political Stability
Property rights refer to the ability of
people to exercise authority over the
resources they own.
 Justice system must protect property
rights. An economy-wide respect for
property rights is an important
prerequisite for the price system to work.

Property Rights and Political Stability
Also, countries with a history of frequent
revolutions are not rich today. Political
stability is necessary for growth.
 It is necessary for investors to feel that
their investments are secure.
Ex: Recently, Hugo Chavez’s Venezuela
nationalized some of the oil extracting
companies. Some Persian Gulf countries
require 51% ownership of home citizens of
any new company.

Free Trade

Some countries engage in . . .



. . . inward-oriented trade policies, avoiding
trade with other countries. Like Cuba.
. . . outward-oriented trade policies,
encouraging trade with other countries. Like
Hong Kong.
Which one is the right policy? Most economists
believe that openness helps development.
Research and Development
The advance of technological knowledge
has led to higher standards of living.
 Most technological advance comes from
private research by firms and individual
inventors.
 Government can encourage the
development of new technologies through
research grants, tax breaks, and the
patent system.

Population Growth

Economists and other social scientists
have long debated how population growth
affects a society.



Malthus’ mistaken theory: geometric
population growth, linear food growth.
Earlier economic theory: faster population
growth causes poverty because it reduces
capital per worker. (if population grows faster
than capital)
More recent theories by Paul Romer and
Michael Kremer argue that population growth
is the driving force behind technological
growth.
Population Growth
Slower population growth also creates
risks for the social security system.
Ratio of number of current workers /
number of retirees decreases. Smaller
inflow and larger outflow of money.
Currently big problem for Turkey.
 Why do developed countries promote birth
control in less developed countries but
give incentives for more children in their
own countries?

Summary
Economic prosperity, as measured by real
GDP per person, varies substantially
around the world.
 The average income of the world’s richest
countries is more than ten times that in
the world’s poorest countries.
 The standard of living in an economy
depends on the economy’s ability to
produce goods and services.

Summary
Productivity depends on the amounts of
physical capital, human capital, natural
resources, and technological knowledge
available to workers.
 Government policies can influence the
economy’s growth rate in many different
ways.

Summary
The accumulation of capital is subject to
diminishing returns.
 Because of diminishing returns, higher
saving leads to a higher growth for a
period of time, but growth will eventually
slow down.
 Also because of diminishing returns, the
return to capital is especially high in poor
countries.
