Chapter 25 - Economic Growth

CHAPTER TWENTY-FIVE ECONOMIC GROWTH

LECTURE NOTES
I. Introduction A. Learning objectives In this chapter students will learn: 1. About the institutional structure an economy needs if it is to experience modern economic growth and ongoing increases in standards of living. 2. About growth accounting and the specific factors to which changes in growth rates can be attributed. 3. Why U.S. productivity growth has accelerated since the mid-1990s. 4. About differing perspectives on whether growth is desirable and sustainable. II. Economic Growth. A. Two definitions of economics growth are given. 1. The increase in real GDP, which occurs over a period of time. 2. The increase in real GDP per capita, which occurs over time. This definition is superior if comparison of living standards is desired. For example, Chinas 2003 GDP was $1410 billion compared to Denmarks $212 billion, but per capita GDPs were $1110 and $33,750 respectively. 3. Growth in real GDP does not guarantee growth in real GDP per capita. If the growth in population exceeds the growth in real GDP, real GDP per capita will fall. B. Growth is an important economic goal because it means more material abundance and ability to meet the economizing problem. Growth lessens the burden of scarcity. C. The arithmetic of growth is impressive. Using the rule of 70, a growth rate of 2 percent annually would take 35 years for GDP to double, but a growth rate of 4 percent annually would only take about 18 years for GDP to double. (The rule of 70 uses the absolute value of a rate of change, divides it into 70, and the result is the number of years it takes the underlying quantity to double.) D. Main sources of growth are increasing inputs or increasing productivity of existing inputs. 1. About one-third of U.S. growth comes from more inputs. 2. About two-thirds comes from increased productivity. E. Growth Record of the United States (Table 25.1) is impressive. 1. Real GDP has increased over sixfold since 1950, and real per capita GDP has risen over threefold. (See columns 2 and 4, Table 25.1) 2. Rate of growth record shows that real GDP has grown about 3.4 percent per year since 1950 and real GDP per capita has grown about 2.1 percent per year. But the arithmetic needs to be qualified.

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III.

Modern Economic Growth A. Modern economic growth is characterized by sustained ongoing increases in living standards that can cause dramatic increases in the standard of living within a generation. B. Economic historians informally date the start of the Industrial Revolution to the year 1776, when Scottish inventor James Watt perfected a powerful and efficient steam engine. C. The Uneven Distribution of Growth 1. Modern economic growth has spread only slowly from its British birthplace. It first advanced to France, Germany, and other parts of Western Europe in the early 1800s before spreading to the Untied States, Canada, and Australia by the mid 1800s. 2. The different starting dates for modern economic growth in various parts of the world are the main cause of the vast differences in per capita GDP levels seen today. 3. Figure 25.1 shows what economists have called the great divergence in income levels around the world as a result of different rates of, and starting dates for, modern economic growth. D. Catching Up is Possible 1. Countries that began modern economic growth more recently are not doomed to be permanently poorer than the countries that began modern economic growth at an earlier date. 2. The poorer follower countries can grow much faster because they can simply adopt existing technologies from rich leader countries. 3. Table 25.2 shows both how the growth rates of leader countries are constrained by the rate technological progress as well as how certain follower countries have been able to catch up by adopting more advanced technologies and growing rapidly. 4. CONSIDER THIS Economic Growth Rates Matter

IV.

Institutional Structures That Promote Growth A. Table 25.2 demonstrates that poorer follower countries can catch up. But how does a country start that process. B. Economic historians have identified several institutional features that promote and sustain modern economic growth. 1. Strong Property Rights 2. Patents and copyrights (see the CONSIDER THIS Patents and Innovation) b. Compounding makes seemingly small differences in growth rates quite significant. c. Over a 70-year period, a 4 percent growth rate will generate twice as much output as a 3 percent growth rate, and nearly four times as much income as a 2 percent growth rate. 3. Efficient financial institutions 4. Literacy and widespread education 5. Free trade 6. A competitive market system

V.

Ingredients of Growth

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A. Four supply factors relate to the ability to grow. 1. The quantity and quality of natural resources, 2. The quantity and quality of human resources, 3. The supply or stock of capital goods, and 4. Technology. B. Two demand and efficiency factors are also related to growth. 1. Aggregate demand must increase for production to expand. 2. Full employment of resources and both productive and allocative efficiency are necessary to get the maximum amount of production possible. VI. Production Possibilities Analysis (Figure 25.2) A. Growth can be illustrated with a production possibilities curve (Figure 25.2), where growth is indicated as an outward shift of the curve from AB to CD. 1. Aggregate demand must increase to sustain full employment at each new level of production possible. 2. Additional resources that shift the curve outward must be employed efficiently to make the maximum possible contribution to domestic output. 3. For the economy to achieve the maximum increase in value, the optimal combination of goods must be achieved (allocative efficiency). VII. Accounting for growth is an attempt to quantify factors contributing to economic growth. A. More labor input is one source of growth. Labor force has grown by 1.7 million workers per year for the past 52 years and accounts for about one-third of total economic growth. B. The growth of labor productivity contributed only about half of the growth from 1973-1993, but was responsible for all it from 1995-2004, and is expected to account for about threefourths of the growth between 2005 and 2011. C. CONSIDER THIS Women, the Labor Force, and Economic Growth 1. The percentage of women working in the paid labor force has risen from 40 percent in 1965 to 56 percent in 2006. 2. Womens productivity has increased with greater investments in human capital. Productivity increases have raised womens wages and increased the opportunity cost of staying home. 3. Reduced birthrates, growth in industries typically attracting women workers, urban migration, increased availability of part-time jobs, and antidiscrimination laws have all increased labor market access for women. E. Technological advance, the most important factor in productivity growth, accounts for 40 percent of productivity growth. F. Increases in quantity of capital are estimated to explain about 30 percent of productivity growth. G. Education and training improve the quality of labor, and account for about 15 percent of productivity growth. (See Figure 25.4) H. Improved resource allocation and economies of scale also contribute to growth and explain about 15% of total productivity growth.

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1. Economies of scale occur as the size of markets and firms that serve them have grown. 2. Improved resource allocation has occurred as discrimination disappears and labor moves where it is most productive, and as tariffs and other trade barriers are lowered. VIII. The Recent Productivity Acceleration A. Improvement in standard of living is linked to labor productivity output per worker per hour (Figure 25.5). B. The U.S. is experiencing a resurgence of productivity growth based on innovations in computers and communications, coupled with global capitalism. Since 1995 productivity growth has averaged 2.9% annually up from 1.4% over 1973-95 period. The Rule of 70 projects real income will double in 24 years rather than 50 years. C. Much of the recent improvement in productivity is due to new economy factors such as: 1. Microchips and information technology are the basis for improved productivity. Many new inventions are based on microchip technology. 2. New firms and increasing returns characterize the new economy. a. Some of todays most successful firms didnt exist 25 years ago: Dell, Compaq, Microsoft, Oracle, Cisco Systems, America Online, Yahoo and Amazon.com are just a few of many. b. Economies of scale and increasing returns in new firms encourage rapid growth. 3. Sources of increasing returns include: a. More specialized inputs. b. Ability to spread development costs over large output quantities since marginal costs are low. c. Simultaneous consumption by many customers at the same time. d. Network effects make widespread use of information goods more valuable as more use the products. e. Learning increases with practice. 4. Global competition encourages innovation and efficiency. D. Even if average growth rates in productivity and real output remain higher over time, business cycle fluctuations (i.e. recessions) can still occur. E. Skepticism about long-term continued growth remains, and only time will tell. IX. Is Growth Desirable and Sustainable? A. An antigrowth view exists. 1. Growth causes pollution, global warming, ozone depletion, and other problems. 2. More is not always better if it means dead-end jobs, burnout, and alienation from ones job. 3. High growth creates high stress. B. Others argue in defense of growth. 1. Growth leads to an improved standard of living. 2. Growth helps to reduce poverty in poor countries.

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3. Growth has improved working conditions. 4. Growth allows more leisure and less alienation from work. 5. Environmental concerns are important, but growth actually has allowed more sensitivity to environmental concerns and the ability to deal with them. C. Is growth sustainable? Yes, say proponents of growth. 1. Resource prices are not rising. 2. Growth today has more to do with expansion and application of knowledge and information, so is limited only by human imagination.

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