Long-Run Economic Growth
Long-Run Economic Growth
Potential GDP: The level of GDP
attained when all firms are
producing at capacity.
Business cycle: Alternating
periods of economic expansion
and economic recession.
Comparing Economies
• Economists measure growth using Real GDP
and perhaps more importantly Real GDP per
capita (GDP per person).
Real GDP in Year 2 - Real GDP in Year 1
Growth in Real GDP =
x100
Real GDP in Year 1
• Real GDP per capita is five times the 1929
level, and 7 times the 1900 level
Example: Compare across countries
Country
2007 Real GDP
(billions)
2008 Real GDP
(billions)
Brazil
$1,295.7
$1,362.6
Mexico
$8,806.7
$8,911.4
Thailand
$4,259.5
$4,368.4
Question: What country experienced the highest growth rate in 2008?
The lowest?
Example: Country A
Year
Real GDP per capita (2005 prices)
2006
$41,552
2007
$42,680
2008
$42,202
2009
$43,194
2010
$43,102
a. What is the % increase in real GDP per capita between 2006 and 2010?
b. What is the average annual real GDP per capita growth rate between 2006
and 2010?
Long-Run Economic Growth
Long-run economic growth: The process by which rising
productivity increases the average standard of living.
Growth Rates
• How did the United States produce seven times
more real GDP per capita in 2000 than in 1900?
• A little bit at a time – power of compounding!
• Long-run economic growth is normally a gradual
process, in which real GDP per capita grows at
most a few percent per year.
Small Differences in Growth Rates Are Important
In the long run, small differences in economic growth rates
result in big differences in living standards.
Why Do Growth Rates Matter?
Growth rates matter because an economy that grows too
slowly fails to raise living standards.
Rule of 70
• During the twentieth century, real GDP per
capita in the United States increased an
average of 1.9% each year.
• The years it takes for a variable that grows
gradually to double is approximately:
Rule of 70
• So at 1.9% growth, how long does it take real
GDP per capita to double?
– ANSWER: 37 Years (approx.)
• So if it takes 37 years to double, how many years to
be 8 times as large?
– ANSWER: Doubling 3 Times = 2 x 2 x 2 = 8
– So it takes 3 x 37 years = 111 years
•
Sources of Long-Run Growth
• Labor productivity, often referred to simply as
productivity, is output per worker (usually one
worker by one hour of work).
• Physical capital consists of human-made resources
such as buildings and machines.
• Human capital is the improvement in labor created
by the education and knowledge embodied in the
workforce.
• Technology: A change in the quantity of output a
firm can produce using a given quantity of inputs.
What Determines How Fast Economies Grow?
There are three main sources of technological change:
• Better machinery and equipment.
• Increases in human capital.
Human capital The accumulated
knowledge and skills that workers
acquire from education and training or
from their life experiences.
• Better means of organizing and
managing production.
Accounting for Growth
• Aggregate Production Function: A hypothetical
function that shows how real GDP per worker
depends on the quantities of physical and
human capital per worker as well as technology.
Diminishing Return to Physical Capital
• Aggregate Production Function exhibits
diminishing returns to physical capital when:
– holding the amount of human capital and the
state of technology fixed
– each successive increase in the amount of
physical capital leads to a smaller increase in
productivity.
Hypothetical Example
Physical Capital and Productivity
Which Is More Important for Economic Growth:
More Capital or Technological Change?
The Per-Worker Production Function
The Per-Worker Production
Function
Growth Accounting
• Growth accounting: estimates the contribution of
each major factor in the aggregate production
function to economic growth.
• Physical capital per worker grows 3% a year.
• According to estimates each 1% rise in physical
capital per worker, holding human capital and
technology constant, raises output per worker by
0.33%.
Technology and Productivity
What Determines How Fast Economies Grow?
Technological Change:
The Key to Sustaining Economic Growth
Technological Change
Increases Output per
Hour Worked
Making
the
Connection
•What Explains the Economic
Failure of the Soviet Union?
A centrally planned economy, such as the Soviet
Union’s, could not, over the long run, grow faster
than a market economy. The Soviet Union collapsed
in 1991, and contemporary Russia now has a more
market-oriented system, although the government
continues to play a much larger role in the economy
than does the government in the United States.
The fall of the Berlin Wall in 1989
symbolized the failure of
Communism.
Natural Resources
• In the modern world, natural resources are a much
less important determinant of productivity than
human or physical capital for the great majority of
countries.
• Some nations with very high real GDP per capita,
such as Japan, have very few natural resources.
Some resource-rich nations, such as Nigeria (which
has sizable oil deposits), are very poor.
What Determines How Fast Economies Grow?
New Growth Theory
If technological change is the key to growth then what encourages
the technological change?
Government policy can help increase the accumulation of
knowledge capital in three ways:
• Protecting intellectual property with patents
and copyrights.
Patent: The exclusive right to a product for a period of 20
years from the date the product is invented.
• Subsidizing research and development.
• Subsidizing education.
Why Growth Rates Differ
• Countries differ greatly in their growth rates of real
GDP per capita, largely due to differences in
government policies and institutions that alter:
savings and investment spending
foreign direct investment
Foreign portfolio investment (new)
education
Infrastructure (Roads, power lines, ports, IT networks
research and development (create/implement tech)
political stability
the protection of property rights
Political Stability & Property Rights
•Property rights: The rights individuals or firms have to
the exclusive use of their property, including the right to
buy or sell it.
•Rule of law: The ability of a government to enforce
the laws of the country, particularly with respect to
protecting private property and enforcing contracts.
Political Stability & Property Rights
•Political stability and protection of property rights are
crucial ingredients in long-run economic growth.
There’s not much point in investing in a business
if rioting mobs are likely to destroy it or saving
your money if someone with political
connections can steal it.
Excessive Government Intervention
•Even when governments aren’t corrupt, excessive
government intervention can be a brake on
economic growth.
If large parts of the economy are supported by
government subsidies, protected from
imports, or otherwise insulated from
competition, productivity tends to suffer
because of a lack of incentives.
Poor Countries Regulate Businesses
The Most….
Success, Disappointment, and Failure
Success in Economic Growth
East Asian economies have done many things
right and achieved very high growth rates.
Savings and Investment Spending
Emphasis on Education
 Adopting advanced technology
Government Stability
Disappointment in Economic Growth
In Latin America, where some important
conditions are lacking, growth has generally been
disappointing.
Poor education
Political Instability
Irresponsible Government
Corruption
Disappointment in Economic Growth
In Africa, real GDP per capita has declined for
several decades, although there are some signs of
progress now.
Severe Political and Economic Instability
Poverty Itself
Disease &War
Geography
Poor Infrastructure
Public Health
Convergence Hypothesis
Convergence Hypothesis: International
differences in real GDP per capita tend to narrow
(converge) over time.
The growth rates of economically advanced
countries have converged, but not the growth rates
of countries across the world
Factors that affect growth, such as education,
infrastructure, and favorable policies and
institutions must be held equal across countries.
Convergence?