An Overview of Long-Run

Economic Growth

OVERVIEW
In this chapter, we learn
some facts related to economic growth that later chapters will seek to explain.
how economic growth has dramatically improved welfare around the world.
that this growth is actually a relatively recent phenomenon.
some tools used to study economic growth, including how to calculate growth
rates and why a ratio scale makes plots o f per capita GDP easier to
understand.

40

Chapter 3: An Overview o f Long-Run Economic Growth

The first step in making things better is to understand why things are the
way they are.
Anonymous

3.1

Introduction

L ets play a game. I ll describe some economic characteristics o f a country, and

you tell me which country I am describing. In this country, life expectancy at
birth is under 50 years, and 1 out o f every 10 infants dies before reaching a
first birthday. M ore than 90 percent o f households have no electricity, refrig
erator, telephone, or car. F ew er than 10 percent o f young adults have gradu
ated from high school. Is it Kenya, or Bangladesh, or perhaps N orth Korea? A ll
good guesses, but in fact the country is the U nited States, not today but at the
end o f the nineteenth century.
Such is the power o f economic growth: in ju st over a century, the U nited
States has been com pletely transformed. A lm ost all households have electric
ity, refrigerators, telephones, and cars. Th e overw helm ing m ajority o f young
adults have graduated from high school, w ith m any going on to college. But
this only hints at the scale o f the transform ation. Th ink o f the new goods that
w ere nearly unim aginable a hundred years ago: air-conditioning, dishwashers,
skyscrapers, je t airplanes, satellites, television, m ovie theaters, DVDs, comput
ers and the Internet, portable music players, and the m ultitude o f other goods
available in supermarkets, restaurants, and superstores.
The tremendous gains in health are equally im pressive. L ife expectancy at
birth in the U nited States is 50 percent higher than a century ago, at more
than 77 years. The great European financier N athan Rothschild, the richest
man in the w orld in the early 1800s, died from an infection that

$10

o f antibi

otics could cure today.

N ot all countries in the w orld have experienced this rapid growth. Th e fact
that the U nited States o f a century ago could be m istaken for K enya or
Bangladesh today is testim ony to an enormous lost opportunity.
This chapter provides an overview o f the basic facts o f economic growth.
W e use statistics on G D P per person to quantify the large differences in eco
nomic performance between the present and the past, and between the rich and
poor countries o f the world today. In the process, w e develop a number o f m ath
em atical tools that are extrem ely useful in studying macroeconomics. Subse
quent chapters in the long-run portion o f this book w ill draw on these tools to
provide economic theories that help us understand the facts o f economic growth.

3.2

Growth over the Very L on g Run

One o f the most im portant facts o f economic growth is that sustained increases
in standards o f livin g are a rem arkably recent phenomenon. Figure 3.1 makes

3.2 Growth over the Very Long Run

41

Figure 3.1

Econom ic G row th o v e r th e V e r y Lon g R u n in Six C ou n tries

Per capita GDP
(1990 dollars)

r On a long tim
e scale,
economic growth is so recent
that a plot o f per capita GDP
looks like a hockey stick, and
the lines fo r different
countries are hard to
distinguish.

Year
Source: Angus Maddison, The W orld Economy: Historical Statistics (Paris: OECD Development Center,

2003).

this point by showing estim ates o f per capita G D P over the last 2,000 years for
six countries. For most o f history, standards o f livin g w ere extrem ely low, not
much different from that in Ethiopia today. Th e figure shows this going back
for 2,000 years, but it is surely true going back even farther. U p until about

12,000

years ago, humans w ere hunters and gatherers, livin g a nomadic exis

tence. Then around 10,000 B.C. came an agricultural revolution, which led to
the em ergence o f settlem ents and eventu ally cities. Y e t even the sporadic peaks
o f economic achievem ent that followed w ere characterized by low average stan
dards o f living. Evidence suggests, for example, that w ages in ancient Greece
and Rome w ere approxim ately equal to w ages in B ritain in the fifteenth cen
tury or France in the seventeenth, periods distinctly prior to the em ergence o f
modern economic grow th .1
It is only in the most recent tw o or three centuries that modern economic
growth em erges, but when it appears, the results are stunning. In the words
o f seventeenth-century English philosopher Thom as Hobbes, life was nasty,
brutish, and short for hundreds o f thousands o f years. Since 1700, however,
livin g standards in the richest countries have risen from roughly $500 per per
son to som ething approaching $30,000 per person today. Incomes have exploded
by a factor o f 60 during a period that is but a flash in the pan o f human

'For more on this evidence, see Robert E. Lucas Jr., Lectures on Economic Growth (Cambridge, Mass.: Har
vard University Press, 2004); and Charles I. Jones, Was an Industrial Revolution Inevitable? Economic
Growth over the Very Long Run," Advances in Macroeconomics, 2001.

4-2

Chapter 3: An Overview o f Long-Run Economic Growth

history. I f the 130,000-year period since modern humans made their first ap
pearance w ere compressed into a single day, the era o f modern growth would
have begun only in the last 3 minutes.
A nother point to be gleaned from F igure 3.1 is that sustained growth
em erges in different places at different times. G rowth first starts to appear in
the United Kingdom and then in the U nited States. Standards o f livin g in Brazil
and Japan begin to rise m ainly in the last century or so, and in China only dur
ing the last several decades. Finally, standards o f livin g in Ethiopia today are
perhaps only twice as high as they w ere over most o f history, and sustained
growth is not especially evident.
A n im portant result o f these differences in tim in g is that livin g standards
around the w orld today va ry dram atically. P e r capita G D P in Japan and the
U nited Kingdom is about 3/4 that in the U nited States; fo r B razil the ratio is
1/5, for China 1/9, and for Ethiopia only 1/45. These differences are especially
stunning when w e consider that livin g standards around the w orld probably
differed by no more than a factor o f 2 or 3 before the yea r 1700. In the last
three centuries, standards o f livin g have diverged dram atically, a phenomenon
that has been called the G re a t D iv e rg e n c e .2

3.3

M odern Economic Growth

On a scale o f thousands o f years like that shown in Figure 3.1, the era o f mod
ern economic grow th is so compressed that incomes alm ost appear to rise as a
vertical line. But i f w e stretch out the tim e scale and focus on the last 125 years
or so, w e get a fu ller picture o f what has been occurring. F igure 3.2 does this
for the U nited States.
M easured in yea r 2000 prices, per capita G D P in the U nited States was
about $2,500 in 1870 and rose to nearly $37,000 by 2004, almost a 15-fold in
crease. A more mundane w ay to appreciate this rate o f change is to compare
G D P in the yea r you w ere born w ith G D P in the year your parents w ere born.
In 1985, for example, per capita income was ju st over $25,000. T h irty years
earlier it was about $13,000. Assum ing this economic grow th continues, the
typical Am erican college student today w ill earn a lifetim e income about twice
that o f his or her parents.

The Definition of Economic Growth

U p to this point, the phrase economic grow th has been used generically to re
fer to increases in livin g standards. H ow ever, grow th also has a more precise
m eaning, related to the exact rate o f change o f per capita GDP.
2See Lant Pritchett, "Divergence, Big Time, Journal o f Economic Perspectives, vol. 11 (Summer 1997),
pp. 3-17, as well as Robert E. Lucas Jr., Some Macroeconomics for the 21st Century," Journal o f Economic
Perspectives, vol. 14 (Winter 2000), pp. 159-68. The term Great Divergence is borrowed from Kenneth
Pomeranz, The Creat Divergence: China, Europe, and the Making o f the Modern World Economy (Princeton,
N.J.: Princeton University Press, 2000).

3.3 Modern Economic Growth

43

Figure 3.2

P e r C apita GDP in th e U n ite d States, 1870-2004

Per capita GDP

(2000 dollars)

Per capita GDP in the United

States has risen by nearly a
^ factor of 15 since 1870._______ ^

Year
Source: Data from

1870 to 1928, Maddison,

The World Economy (see Figure 3.1). Data from

1929 to 2004 . U.S.

Department o f Commerce, Bureau o f Economic Analysis.

N otice that the slope o f the income series shown in Figure 3.2 has been ris
ing over time: our incomes are rising by an ever-increasing amount each year.
In fact, these income changes are roughly proportional to the level o f per capita
income at any particular time.
Some algebra m ay help us see w hat this statem ent means. L e t y stand for
per capita income. Then, at least as an approximation,
y2005 y2004 - g "X3*2004,
where, as w e w ill see, the num erical value for g turns out to be about

0.02.

Th at is, the change in per capita income between 2004 and 2005 is roughly pro
portional to the level o f per capita income in 2004, w here the factor o f propor
tionality is

percent.

D ivid in g both sides o f this equation by income in 2004, w e discover another

w ay o f expressing this relationship:
.y2005 ~ .V2004 _
^2004
The left-hand side o f this equation is the percentage change in per capita in
come. This expression says that the percentage change in per capita income is
the constant g, and it is this percentage change that w e call a grow th rate.

44

Chapter 3: An Overview o f Long-Run Economic Growth

W e can look at the grow th rate between any two consecutive years. Sup
pose yt is income in some period. Then w e could study the grow th rate between
2003 and 2004, or 1950 and 1951, or m ore generally between yea r t and year
t + 1. This leads us to the follow ing general definition: a g ro w th ra te in some
variable y is the percentage change in that variable. Th e growth rate between
period t and t +

is

:y<+i - yt
yt
From this definition o f a grow th rate as a percentage change, w e can de
rive a number o f useful insights. For example, i f the grow th rate o f per capita
income happens to equal some number g, then w e can express the level o f per
capita income as
yy+i =y<d + #)

(3.1)

This equation is useful because it allows us to determ ine the value o f per capita
income tom orrow i f w e know the value today and the grow th rate.

A Population Growth Example

To see equation (3.1) in action, consider the follow ing exam ple. Suppose the
population o f the w orld is given by L 0; we m ight suppose L 0 is equal to

bil

lion, to reflect the number o f people in the world today. N ow consider the pos
sibility that population grow th w ill be constant over the next century at a rate
given by n. For exam ple, n m ight equal 0.02, im plying that the w orlds popula
tion w ill grow at 2 percent per year. U nder these assumptions, w hat w ill the
level o f the population be

100

years from now?

In sertin g our population notation into equation (3.1), w e have

L t+\ = L t( l + n).

(3.2)

The population next year is equal to the population this y ea r m ultiplied by (1

plus the growth rate). W hy? W ell, the 1 sim ply reflects the fact that w e carry
over the people who w ere already alive. In addition, for every person at the
start, n new people are added, so w e must add n L t people to the original pop
ulation L t.
L e ts apply this equation to our example. W e begin at year 0 w ith L o peo
ple. Th en at year 1 w e have
L\ = L 0( l + n).

(3.3)

Sim ilarly, w e can calculate the population in yea r 2 as

L2 = L i(l + n).
But w e already know the value o f L x from equation (3.3). Substituting from
this equation, w e have
L 2 = L 0( l + nXl + n) = L 0( l + n)2.

(3.4)

3.3 Modern Economic Growth

W hat about the population in yea r 3? Again, w e take our basic growth equa
tion, L 3 = L 2( 1 + n), and substitute the expression for L 2 from equation (3.4),
which gives
L 3 = (L0( l + n)2)d + n) = L 0( l + n)3.

(3.5)

A t this point, you should start to see a pattern. In particular, this process sug
gests that the population in any arbitrary yea r t is
L, = L 0( 1 + nY.

(3.6)

This is the key expression that w e need to answ er our original question:
given values for Lo and n, w hat w ill the w orld population be

100

years from

now? Evalu ating equation (3.6) at t = 100, w e get

L io o = L 0( l + n )100.

W ith L 0 =

billion and n = 0.02, w e thus find that the population 100 years

from now would equal 43.5 billion.

M ore generally, this exam ple illustrates the follow ing im portant result,
known as the con stan t g ro w th ru le: i f a variable starts a t some in itial value
y 0 at tim e

and grows at a constant rate g , then the value o f the variable at

some future tim e t is given by

yt =y0a +g)

(3.7)

Th ere is one more lesson to be learned from our simple population exam
ple. Equation (3.6) provides us w ith the size o f the population at any tim e t,
not ju st t = 100. In principle, w e can use it to produce a plot o f the population
at each point in time. W hat do you think such a plot would look like? T ry m ak
ing one on your own, w ith a calculator and a judicious choice o f a few years, or
even w ith a computer spreadsheet program. You should end up w ith a plot that
looks like Figure 3.3. W here have you seen a graph that looked som ething like
this before? W h ile the numbers are different, the signature growth curve here
looks a lot like the pattern o f per capita G D P in the U nited States, shown in
Figure 3.2. It is this sim ilarity that w e explore next.

The Rule of 70 and the Ratio Scale

A m ajor shortcom ing o f a figure like 3.2 or 3.3 is that its difficult to see the
rate o f grow th in the figure. F or exam ple, is it possible to tell from F igure 3.3
that the rate o f growth o f the w orld population is constant over the

100 years?

N ot really. In Figure 3.2, is the average grow th rate increasing, decreasing, or

constant? A gain, its nearly impossible to tell.
Fortunately, there is an altern ative w ay o f plotting these figures, called a
ratio scale, that makes it much easier to see w hat is happening to the growth
rate. Suppose a country called U topia has a per capita income that exhibits a
constant grow th rate g. H ow m any years does it take before income doubles?

45

46

Chapter 3: An O verview o f Long-Run Economic Growth

Figure 3.3

P o p u la tio n o v e r Time
Population L (billions)

\
This graph shows the level o f
the population computed
according to Lt = Lo (1 + n )'
fo r lo = 6 and n = 0 .02 .

V__________ _____________ J

Year

I f income starts at y o, w e are asking how m any years it takes until yt = 2 X y 0.

W e know from the constant grow th rule in equation (3.7) that y t = y o (l + g ) 1So per capita income w ill double when

yt = 2y0 = y o d + g ) 1
=>2

(1 +gY.

(3.8)

Th at is, i f income is grow ing at rate g , then the number o f years it takes until
income doubles is the value o f t such that 2 = (1 -I- g ) . S olving this equation for
t requires you to take the logarithm o f both sides o f the equation. H ere, it is
sufficient for us sim ply to note the bottom line, which is im portant enough to
have its own name, the R u le o f 70: i f y t grows at a rate o f g percent per year,
then the num ber o f years it takes y t to double is approxim ately equal to 70/g.
For exam ple, i f y t grows at 2 percent per year, then it doubles about every
70/2 = 35 years .3
Th ere are two points to note about the Rule o f 70. First, it is ve ry inform
ative in its own right. I f a countrys income grows at 1 percent per year, then
it takes about 70 years for income to double. On the other hand, i f growth is
slightly faster at 5 percent per year, then income doubles every 14 (70/5) years.
Seem ingly sm all differences in grow th rates lead to quite different outcomes
when compounded over time. This is a point w e w ill return to often through
out the next several chapters.

^logarithms help you see how this rule is derived. Taking natural logs of both sides of equation (3.8) gives
In 2 = t x ln(i + 7 ).

Next, note that In 2 = 0.7 and ln(i + q) = g, so this equation can be written as

t = O.7/3.
To get our rule, we multiply the top and bottom of this fraction by 100 so that the growth rate is expressed
as a percent.

3.3 Modern Economic Growth

47

F i g u r e 3.4

P o p u la tio n o v e r Time, R evisited

Population L (billions)
Population L (billions)

(ratio scale)

50 r -

48 r -

_4_8_ _

These graphs show the level

o f the population computed

40
24

according to L t = L q (1 + n ) '
fo r to = 6 and n = 0.02. The

30

vertical scale in part (b) is a

12

20

ra tio scale, so that equally

spaced intervals are

10

associated with a doubling o f

population.
20

40

60

80

100

20

40

60

80

Year

100
Year

(a ) On a standard scale...

(b) and a ratio scale.

Th e second im plication o f the Rule o f 70 is that the tim e it takes for income
to double depends only on the grow th rate, not on the current level o f income.
I f a countrys income grows at 2 percent per year, then it doubles every 35
years, regardless o f w hether the in itial income is $500 or $25,000.
How does this observation help us? First, lets go back to our population
example, reproduced in a slightly different w ay in Figure 3.4. In part (a), be
cause population is grow ing at a constant rate o f 2 percent per year, it w ill dou
ble every 35 years; the points when the population hits

6 billion

(today), 12 bil

lion, 24 billion, and 48 billion are highlighted.

N ow consider w hat happens i f w e squish the vertical axis o f the popula
tion plot so that the key doubling points the

6,

12, 24, and 48 billion points

are equally fa r apart. Th at is, rather than labeling the vertical axis in the usual
1, 2, 3, 4 fashion, w e label it as 1, 2, 4,

so that each interval represents a

doubling; this is shown in part (b). Som ething rem arkable happens: w hat was
previously an ever-steepening curve has turned into a straight line. I f the pop
ulation is grow in g at a constant rate, w e should hit our equally spaced m ark
ers every 35 years, and this is exactly w hat happens.
Squishing the vertical axis this w a y creates a ra tio scale:4 a plot w here
equally spaced tick marks on the vertical axis are labeled consecutively w ith
numbers that exhibit a constant ratio, like 1, 2, 4,

8, .

(a constant ratio o f

2) or 10, 100, 1,000, 10,000, . . . (a constant ratio o f 10). Plotted on a ratio

scale, a variable grow in g at a constant rate appears as a straight line.

U.S. GDP on a Ratio Scale

The ratio scale is a tool that allows us to quickly read grow th rates from a
graph. For example, consider w hat w e can learn by plotting U.S. per capita
G D P on a ratio scale. I f income grows at a constant rate, then the data points
4 |n

computer spreadsheet programs, a ratio scale is sometime called a logarithmic scale.

48

Chapter 3: An O verview o f Long-Run Economic Growth

should lie on a straight line. A ltern atively, i f growth rates are rising, w e would
expect the slope between consecutive data points to be increasing.
Figure 3.5 shows the same data as F igure 3.2, per capita G D P in the U nited
States, but now on a ratio scale. N otice that the vertical axis here is labeled
2, 4,

8,

16 doubling over equally spaced intervals. Quite rem arkably, the

data series lies close to a line that exhibits a constant slope o f

2.0

percent per

year. This means that to a first approximation, per capita G D P in the U nited
States has been grow ing at a rela tively constant annual rate o f 2.0 percent over
the last 135 years.
A closer look at the figure reveals that the growth rate in the first h a lf o f
the sam ple was slightly low er than this. For example, the slope between 1870
and 1929 is slightly low er than that o f the 2.0 percent line, w hile the slope be
tween 1950 and 2004 is sligh tly higher. These are points that w e can easily see
on a ratio scale, as opposed to the standard linear scale in F igure 3.2.

Calculating Growth Rates

Figure 3.5 raises a couple o f interestin g questions. H ow can w e tell that the
grow th rate associated w ith the straight line is 2 percent instead o f 5 percent
or

percent? M ore generally, given some data on income or population, how do

w e compute a growth rate?

First, the fact that the graph is a straight line on a ratio scale tells us that
the grow th rate is constant. To get the actual rate o f 2 percent, there are two

Figure 3.5

P e r C apita GDP in th e U n ite d States, 1870-2004: Ratio Scale

Per capita GDP
(ratio scale, 2000 dollars)

This is the same data shown

in Figure 3.2, but plotted
using a ratio scale. Notice
that the ratios o f the equally
spaced labels on the vertical
axis are all the same, in this
case equal to 2. The dashed
line exhibits constant
growth at a rate o f 2.0
percent per year.

Year

3.4 Modern Growth around the W orld

approaches. F or a quick estim ate, w e can use the Rule o f 70. I f you look closely
at Figure 3.5, you w ill see that the straight line is doubling about every 35
years. F or example, between 1900 and 1935, the line rises from about $4,000
to about $8,000; between 1935 and 1970, it doubles again to about $16,000.
From our Rule o f 70, w e know that a process that doubles every 35 years is
grow ing at 2 percent per yea r (70/35 = 2).
To get a more precise measure o f the growth rate, w e need the raw data. I f
the data for every year are available, w e could compute the percentage change
across each annual period, and this would be a fine w ay to measure growth. But
w hat i f instead w e are given data only for the start and end o f this series? For
example, suppose w e know that U.S. per capita G D P was $2,500 in 1870 and
$37,500 in 2005. W hat is the average annual grow th rate over these 135 years?
The answer can be found by applying the constant growth rule in equation
(3.7): that is, for a quantity grow in g at a constant rate, the level in year t is
given by yt = y 0( l + g ) 1. W hen w e encountered this rule earlier, w e assumed we
knew y 0 and g and wanted to solve for the value o f y at some future date t.
N ow , though, w e are given values o f y t andyo and asked to solve for g. Th e w ay
to do this is to rearrange the equation and the take the tth root o f the ratio o f
the tw o incomes, as explained in the rule for computing growth rates: the
average annual grow th rate between year

0 and

yea r t is given by

/'Vt\Vt
yo/

- i

(3.9)

N ote that i f there were constant grow th between year 0 and year t, the growth
rate w e compute would lead income to grow fr o m y 0 to y t. W e can, however, ap
ply this form ula even to a data series that does not exhibit constant growth,
like U.S. per capita GDP. In this case, w e are calculating an average annual
growth rate. In the special case where t = 1, this rule yields our fa m iliar per
centage change calculation for the growth rate, here (y i yoVyoI f w e apply equation (3.9) to the U.S. per capita G D P numbers, the aver
age annual grow th rate is

/ 37 50 0 \ 1/135

(fir )

- 1= 00203-

which ju stifies the rate o f 2.0 percent reported in Figure 3.5.

3.4

M odern Growth around the W orld

Figure 3.6 uses the ratio scale to exam ine the behavior o f per capita G D P in
seven countries over the last century. In the late nineteenth century, the U nited
Kingdom was the richest country in the world, but it slipped from this position
several decades la ter because it grew substantially slower than the United
States. N otice how flat the per capita income line is for the U .K. relative to the
U nited States. Since 1950, the U nited States and the U .K. have grown at more

49

50

Chapter 3: An Overview o f Long-Run Economic Growth

Figure 3.G

P e r C apita GDP in S even C oun tries, 1870-2000

Per capita GDP
(ratio scale, 1990 dollars)

Year
Source: Maddison, The W orld Economy (see Figure 3.1). Observations are presented every decade after 1950 and less
frequently before that as a way o f smoothing the series.

or less the sam e rate (indicated by the parallel lines), w ith income in the U.K.
staying at about 3/4 the U.S. level.
Germ any and Japan are examples o f countries whose incomes lagged sub
stantially behind those o f the U nited Kingdom and the U nited States over most
o f the last 135 years. Follow ing W orld W a r II, however, growth in both coun
tries accelerated sharply, w ith growth in Japan averaging nearly

6 percent

per

year between 1950 and 1990. Th e rapid growth gradually slowed in both, and
incomes have stabilized at something like 3/4 the U.S. level for the last two
decades, sim ilar to the income level in the U nited Kingdom. This catch-up be
havior is related to an im portant concept in the study o f economic growth known
as convergence. You m ight say that income levels in Germ any and Japan have
converged to the level in the U nited Kingdom during the postwar period.
Economic grow th in Brazil shows a different pattern, one that, to m ake a
vast and somewhat unfair generalization, is more typical o f grow th in Latin
Am erica. Between 1900 and 1980, the country exhibited substantial economic
growth, w ith income reaching nearly 1/3 the U.S. level. Since 1980, however,
grow th has slowed considerably, so that by 2000 income rela tive to the U nited
States was ju st over 1/5.
China shows som ething o f the opposite pattern, w ith grow th rea lly picking
up after 1978 and reaching rates o f more than

6 percent

per yea r for the last

two decades. A country often grouped w ith China in such discussions is India,
in part because the tw o countries together account for more than 40 percent o f
the w orlds population. Indias per capita G D P (not shown in the graph) looks
somewhat sim ilar to Chinas, especially before 1980. But since then, its growth
has been slower, averaging 3.8 percent per yea r between 1980 and 2000. By

3.4 Modern Growth around the W orld

51

2000, Chinas per capita income was about 1/9 the U.S. level, w hile Indias was
ju st over 1/13.
These last numbers m ay come as a surprise i f you take only a casual glance
at F igure 3.6; at first it appears that by 2000 Chinas income was more than
h a lf the U.S. level. But rem em ber that the graph is plotted on a ratio scale:
look at the corresponding numbers on the vertical axis.

A Broad Sample of Countries

Figure 3.7 shows income levels and growth rates for a much larger sample o f
countries. The horizontal axis represents per capita G D P in the year 2000 rela
tive to the United States. A part from Luxem bourg (a small European country
with under h a lf a m illion people, about the size o f Omaha, Nebraska), the United
States had the highest per capita G D P in the world that year. Other rich coun
tries include Hong Kong, Ireland, Israel, Japan, Norway, South Korea, and Spain,
with incomes between 1/2 and 3/4 the U.S. level. Middle-income countries like
Malaysia, Mexico, and Argentina had incomes about 1/3 the U.S. level. China,
India, Indonesia, and Zimbabwe are examples o f countries w ith relative incomes
between 1/16 and 1/8. Finally, Tanzania, Burundi, and Ethiopia, among the poor
est countries o f the world in 2000, had incomes as low as 1/64 the U.S. level.
The vertical axis illustrates the w ide range o f grow th rates that countries
have experienced since 1960. The fastest-grow ing countries over this period in
clude South Korea, H ong Kong, Thailand, China, Japan, and Ireland, all w ith

Figure 3.7

L eve ls a n d G row th R ates of P e r C apita GDP

P e r c a p ita GDP gro w th
(1 9 6 0 to 2 0 0 0 )

0.06 p

^S o u th Korea
Hong Kong
Thailand
China

0.04
Republic of Congo^
Pakistan 9

Romania
lndo" u # ^ ^
Morocco Svn, Republic
# |n d l a V ' #

S rila n l ^

0.02

*
Malaysia

F*vnt

Barbados

Jap

# Portugal
Mauritius
#
L aem b o u ,*
G re e c e *
Spain

^
I s r a e l
/C a n a d a

Brazil

Netherlands

United States

Z,m ^

MaUwi,
G uinea-B issau-

Uganda

p*
f
> ' " UnIted^ l
N'P *'
* E c u a d o ^ ^Colom bia MexK0
Kingdom Swe<^en
Bangladesh
f
U ru g u ay
#
Switzerland

t . *# .
0.00

m
Burundi

Llcl Afnca
V
Gambia
_
^ B oV
l i v i >c\ C o ,su R
Mali
*

Jamaica
T

Honduras

Equatorial Guinea
* ^R w an d a S en eg al Guln' a
^

N ig eria*

' * chad
Zambia

Comoros

Veneiuela

Nicaragua

0.02 _____i_______ i_______ i_______ i_______ i_______ i_______ i_________

1/64

1/32

1/16

1/8

1/4

1/2

1
P e r c a p ita GDP
(r a tio sc ale , U.S. = 1)

Source: Penn World Tables, Version

6 .1. See the "Country Snapshots" file, snapshots.pdf, available from the course web

page for these data. The level o f per capita GDP Is taken from the year 2000 and is normalized so that the U.S. value
equals 1.

and 2000 range from - 2 %

to + 6 % per year. Per capita
GDP in 2000 varies by about
a factor o f 64 across
countries.

Niger

Growth rates between 1960

52

Chapter 3: An Overview o f Long-Run Economic Growth

average growth rates between 4 and

6 percent

per year. A t the other end o f the

spectrum are N iger, Nicaragua, Mozam bique, Madagascar, and Venezuela, each
o f which exhibited negative average grow th over this 40-year period. The bulk
o f the countries lie between these two extrem es. F or exam ple, grow th rates in
Lesotho, Zim babwe, Turkey, M exico, and the U nited Kingdom all hover around
2 percent. A number o f poor countries saw growth rates above this average, in
cluding B razil, Congo, Egypt, India, Indonesia, M auritius, and Pakistan.
The importance o f these differences in growth rates is hard to overestim ate.
In Japan, for example, which is grow ing at

percent per year, incomes w ill

double every 12 years (rem em ber the Rule o f 70). O ver the course o f a h a lf cen
tury about tw o generations incomes w ill increase by a factor o f 24 = 16. In
a country like Japan, young adults are 16 tim es richer than their grandpar
ents. But in countries like N icaragua, Madagascar, and Venezuela, standards
o f livin g have been stagnant across these same tw o generations.

case stu d y:

People versus Countries

Figure 3.8 takes a different perspective on econom ic grow th and treats the person
rather than the country as the unit o f observation. Rather than letting China count
as 1 observation out o f 150 countries, for exam ple, w e count the 1.25 billion p e o
ple in China as about one-fifth o f the w o rld s population. T h e figure, in other w ords,
plots the distribution o f the w o r ld s population according to per capita GDP. It sh o w s
the fraction o f people living in countries that have a per capita GDP b e lo w the n u m
ber on the horizontal axis. Importantly, this per capita GDP is m easu red as a frac
tion o f U.S. per capita GDP in the y ear 2000.

Figure 3.8

The D is trib u tio n of W o rld P o p u la tio n b y P e r C apita GDP, 19E0 a n d 2000

Share o f world population
(percent)

The graph shows, fo r 1960

and 2000 , the percentage o f
the w orlds population living
in countries w ith a per
capita GDP less than or equal
to the number on the
horizontal axis. This per
capita GDP is relative to the
United States in the y e a r
2000 fo r both lines.

Source: Penn World Tables, Version

6 .1.

GDP per capita

(U.S. = 1 in 2000)

3.5 Some Useful Properties o f Growth Rates

A couple o f interesting facts are revealed b y the figure. First, the gen eral grow th
rate o f per capita GDP throughout the w o rld is evident in the w a y the distribution
shifts out over time. The bu lk o f the w o rld s population is substantially richer to
day than it w a s in 1960. Second, the fraction o f people living in poverty has fallen
dram atically in the last h a lf century. In 1960, 2 out o f 3 people in the w o rld lived
in countries w ith a p er capita GDP less than 5 percent o f the 2000 U.S. level. In
other w o rd s, in tod ays prices, these people m ad e about $5 per day. By 2000, the
fraction living in this kind o f poverty h ad fallen to less than 1 out o f 10. If the d is
tribution h ad rem ained u n ch an ged from its 1960 level, m ore than 4 billion p e o
ple w o u ld fall b e lo w this poverty threshold today. Instead, becau se o f econom ic
grow th, only abou t 600 m illion do. One o f the m ajo r reason s for this h as been the
rapid econom ic gro w th in India and China, w h ich together account for m ore than
40 percent o f the w o rld s population.5

r Som e U seful P r o p e rtie s of

i u Growth R ates

As w e develop models o f economic growth, three simple properties o f growth

rates w ill prove extrem ely valuable. These properties are sum m arized below.
G ro w th ra te s o f ratios, p rod u cts, an d p o w e rs: Suppose two variables
x and y have average annual grow th rates o f g x and gy, respectively. Then
the follow ing rules apply:
1. I f 2 = x / y , then gz = gx - gy.
2. I f 2 = x X y , then gt = gx + gy.
3. I f 2 = x, then gz = a x gx.
In these expressions, g z is the average annual grow th rate o f z.
These simple rules explain how to compute the growth rate o f (1) the ratio
o f two variables, (2) the product o f two variables, and (3) a variable that is raised
to some power .6 For example, suppose g x = 0.02 and gy = 0.02, so that x and y
are both growing at 2 percent per year. W h at must then be true about the ratio
5For a more sophisticated version of this argument, see Xavier Sala-i-Martin, The World Distribution of
Income: Falling Poverty and . . . Convergence, Period, Quarterly Journal o f Economics, vol. 121 (May 2006),
pp. 351-97. The paper shows that the conclusion holds up even if we account for how the income distri
bution within countries may have changed.
6These rules should be thought of as approximations that are very good when growth rates are small.
With the aid of calculus, they can be shown to hold exactly for instantaneous growth rates. Consider the
second rule, for the product of two variables. In this case, we have

Now notice that

h _ *ti x Yl ii
*
Xt
* '

1 = (l + gt), and that a similar expression holds for x and y . Therefore,

(i + gt) = (i + g,)( 1 + gy) = i + g* + gy + g ^ y

Then g , ~ gx + gy as long as g^gy is small. You can check that this approximation works well by plugging in
some numbers.

S3

54

Chapter 3: An O verview o f Long-Run Economic Growth

Table 3.1

E xa m p les of G row th Rate C a lc u la tio n s

Suppose x grows at rate gx = 0.10 and y grows at rate gy = 0.03.
What is the growth rate of z in the following cases?
z= xXy

z = x/y
z = y/x
z - X2
z yvz

=>
=>
=>

9i = 9*+9y = -!3
9 z = 9 *~ 9 y = -07
9z = 9y~ 9 * = - 7
9z = 2'><9*= 20
gz = . 5 Xg y = .015
gz = . 5 X g x - .25 X g y = .0425

2 ^l/2y1/4

x/y? I f both the numerator and denominator are growing at the same rate, then
surely the ratio must be constant. This is exactly w hat the first rule implies.
N ow suppose g x = 0.05 instead. In this case, the num erator grows faster
than the denominator, so w e would expect the ratio to grow as w ell. In fact,
rule 1 says the grow th rate o f the ratio should equal g x - g y = 0.05 - 0.02 =
0.03, so the ratio o f x to y w ill now grow at 3 percent per year.
N ext, consider the second rule. I f g x = 0.04 and g y = 0.02, w hat w ill the
growth rate o f z = x X y be? Surely z m ust grow faster than x, since w eve m ul
tiplied x by som ething th at is growing. Rule 2 says that the grow th rate o f the
product o f two variables is the sum o f the tw o grow th rates.
These first two rules illustrate an elegant property o f growth rates: growth
rates obey mathematical operations that are one level simpler than the opera
tion on the original variables. Division o f the variables becomes subtraction o f the
growth rates; multiplication o f the variables becomes addition o f the growth rates.
A s rule 3 shows, this same kind o f sim plification occurs when w e look at
exponentiation. To begin w ith a simple exam ple, suppose y grows at rate g y.
W hat is the grow th rate o f z = y 2? Since y 2 = y X y, w e can apply our m u ltipli
cation rule to see th a tg z = gy + gy = 2 X gy. Sim ilarly, the grow th rate o f y 3 w ill
be 3 X g y, and the grow th rate o f y 10 w ill be 10 X gy. This result generalizes to
any exponent, including negative ones.
Table 3.1 shows some ways to apply these rules, and Figure 3.9 gives a prac
tical example. Total G D P in an economy is equal to the product o f per capita G D P
and the population. Therefore the growth rate o f G D P is the sum o f the growth
rates o f per capita G D P and population. This can be seen graphically in the fig
ure in the three different slopes. W e w ill use these growth rules extensively in the
chapters that follow, so you should memorize them and be prepared to apply them.

case stu d y :

Growth Rules in a Famous Example,

Y ,

A t K \ / 3 L i /3

This w e ll-k n o w n e x a m p le incorporates one o f the key equations o f m acroeconom

ics, w h ich w e w ill return to often in com ing chapters. For n ow , w e ll see h o w it
illustrates our grow th rules.

3.5 Some Useful Properties o f Growth Rates

55

Figure 3.9

U.S. P o p u la tio n , GDP, a n d P e r C apita GDP, 1870-2005

Ratio scale

The growth rate o f total GDP

is the sum o f the growth rate
o f per capita GDP and the
growth rate o f the
population.

____________________

Sources: Maddison, The W orld Economy (see Figure 3.1). and the Bureau o f Economic Analysis.

Suppose w e have an equation that says a variable Y t is a function o f som e

other variables A t, Kt> and Lt. In particular, this function is

y,

a ,k Y 3l ? 3.

W h a t is the grow th rate o f Y t in term s o f the grow th rates o f A t, Kt, and Lt?
H eres w h e re w e apply our grow th rules. O u r second rule says that the grow th
rate o f the product o f certain variables is the su m o f the v a ria b le s grow th rates.7
So

g(Yt) = g(At)

g l t f 3) + g(L ?3).

(W e write Y t, A t, and so on in parentheses here rather than as a subscript to avoid

the a w k w a rd notation that w o u ld result.) Next, w e can use the third rule to com
pute the grow th rates o f the last tw o term s in this expression: the grow th rate o f
a variable raised to som e p o w e r is eq u al to that p o w e r times the grow th rate o f
the variable. Therefore, w e have

g(Yt) = g(A,) + ^ x g(Kt) + j x g (L t).

A n d thats the a n sw e r w e are looking for. A s w e w ill see in later chapters, this
equation says that the grow th rate o f output Y can b e decom posed into the grow th
rate o f a productivity term A and the contributions to grow th from capital K and
labor L.
^Although the original rule applied to the product of two variables, it applies equally well to three or more
variables. For example, if z = wxy, then g[z) = g(w) + g(xy) = g(w) + g[x) + gly).

56

Chapter 3: An O verview o f Long-Run Economic Growth

3.6

The C o s t s o f Economic Growth

W hen we consider economic growth, w hat usually comes to mind is the enormous
benefits it brings: increases in life expectancy, reductions in infant mortality,
higher incomes, an expansion in the range o f goods and services available, and
so on. But what about the costs o f economic growth? H igh on the list o f costs are
environmental problems such as pollution, the depletion o f natural resources,
and even global warm ing. Another by-product o f economic growth during the last
century is increased income inequality certainly across countries and perhaps
even within countries. Technological advances m ay also lead to the loss o f cer
tain jobs and industries. For example, automobiles decimated the horse-andbuggy industry; telephone operators and secretaries have seen their jobs rede
fined as information technology improves. M ore than 40 percent o f U.S. workers
w ere employed in agriculture in 1900; today the fraction is less than 2 percent.
The general consensus among economists who have studied these costs is
that they are substantially outweighed by the overall benefits. In the poorest
regions o f the world, this is clear. W hen 20 percent o f children die before the
age o f 5 as they do in much o f A frica the essential problem is not pollution
or too much technological progress, but rather the absence o f economic growth.
But the benefits also outweigh the costs in richer countries. For example,
w hile pollution is often associated w ith the early stages o f economic growth as
in London in the mid-1800s or Mexico C ity today environmental economists
have documented in inverse-U shape for this relationship. Pollution grows worse
initially as an economy develops, but it often gets better eventually. Smog levels
in Los Angeles are substantially less today than they w ere 30 years ago; one rea
son may be that cars in California produce noxious emissions that are only 5 per
cent o f their levels in the mid-1970s. Technological change undoubtedly elim i
nates some jobs, and there is no denying the hardship that this can cause in the
short run. But as we w ill see in Chapter 7 the unemployment rate in the
U nited States today is on par w ith the levels in the 1960s. Jobs disappear, but
new ones are created. Th e decline in agriculture and the demise o f the fam ily
farm are the flip side o f the tremendous rise in agricultural productivity.
It is indisputable that economic growth entails costs, especially in certain
tim es and certain places and for certain people. In general, however, these costs
are more than offset by the benefits o f economic grow th .8

3.7

A Long-Run Roadmap

In this chapter, w e have seen some o f the key em pirical facts related to eco
nomic growth. W e have also been introduced to im portant tools that w ill help
sFor more on the costs and benefits of growth, see the following: E. J. Mishan, The Costs o f Economic
Crowth (New York: Praeger, 1993); Charles I. Jones, Introduction to Economic Growth (New York: Norton,
2002), Chapter 9; William Nordhaus, "Lethal Model 2: The Limits to Growth Revisited, Brookings Papers
on Economic Activity, vol. 2 (1992), pp. 1-59 . The facts about smog in California are from the California Air
Resources Board, "Fact Sheet: Reducing Emissions from California Vehicles, February 23, 2004.

3.7 A Long-Run Roadmap

us in the coming chapters as w e build models o f how an economy behaves over

the long run.
The next three chapters are prim arily concerned w ith developing theories
that help us understand the facts o f economic growth. Chapter 4 focuses on ex
plaining differences in levels o f income across countries using production func
tions. Chapter 5 develops one o f the canonical models o f macroeconomics, the
Solow growth model. And Chapter

6 studies

the economics o f knowledge its e lf

to provide a richer understanding o f the sources o f grow th and income differ

ences. Th e last two chapters o f the long run section o f this book then turn
away from economic growth to consider the labor m arket and the determ ina
tion o f w ages and the unem ploym ent rate in the long run (C hapter 7) and the
long-run determ inants o f inflation (C hapter

8).

It should be clear at this point that the study o f economic grow th is o f

far more than academic interest. Th e U nited States o f a century or tw o ago
doesnt look that different from the poorest countries in the world today. But
Am ericans today are more than 50 tim es richer on average than people in these
poor regions. The rapid grow th exhibited by Japan after W orld W ar I I or by
China in recent decades has the power to elim inate poverty there in a single
generation: grow in g at

percent per year, incomes w ill double in

quadruple in 24 years, and increase by a factor o f

8 in

12

years,

36 years. A t these rates,

even a 50-fold gap could be closed in three generations.

In 1985, Robert E. Lucas Jr. who would go on to w in the N obel P rize in
Economics in 1995 delivered his now-famous M arshall Lectures at Cam bridge
U niversity. These lectures, which laid out the facts o f economic growth, much
as in this chapter, w ere instrum ental in stim ulating an explosion o f research
on the subject in the decades that follow ed .9 Th ere is perhaps no better w ay to
conclude this chapter than to let Lucas h im self have the last word:
I do not see how one can look at figures like these without seeing them as
representing possibilities. Is there some action a government of India could take
that would lead the Indian economy to grow like Indonesias or Egypts? If so,

what exactly? If not, what is it about the nature of India that makes it so?
The consequences for human welfare involved in questions like these are simply
staggering: Once one starts to think about them, it is hard to think about
anything else.10

9The other important stimulus was a set of papers by Paul Romer on the economics of ideas. This work
will be discussed extensively in Chapter 6.
'From "On the Mechanics of Economic Growth," Journal o f Monetary Economics, vol. 22 (1988), p. 5.

57

58

Chapter 3: An Overview o f Long-Run Economic Growth

3.8

Additional R e s o u r c e s

You m ay find these additional resources o f interest. For articles published in

academic journals, try Google Scholar (scholar.google.com): ju st type in the au
thors nam e and a word from the title o f the paper. M any universities have on
line subscriptions to academic journals.
W. Michael Cox and Richard Aim , Tim e Well Spent: The D eclin in g R eal Cost o f
L iv in g in Am erica, 1997 Annual Report, Federal Reserve Bank o f Dallas,
www.dallasfed.org/fed/annual/1999p/ar97.pdf
Robert E. Lucas Jr., Some Macroeconomics for the 21st Century, Journ al o f
Econom ic Perspectives, vol. 14 (W inter 2000), pp. 159-68.
Much o f the data in this chapter, especially from before 1950, is taken from an
online update o f Angus Maddison, The W orld Economy: H istorical Statistics
(Paris: OECD Development Center, 2003). These data are available from
the Historical Statistics section o f Maddisons web page at www.ggdc.net/
maddison/.
Data on per capita income and growth rates since 1950 for most o f the
countries in the world can be found in the Country Snapshots file,
snapshots.pdf, available from wwnorton.com/college/econ/chad.
C IA W orld Factbook, www.cia.gov/cia/publications/factbook/.

Summary
1.

View ed over the long course o f history, sustained growth in standards o f liv
ing is a ve ry recent phenomenon. I f the 130,000 years o f human history w ere
w arped and collapsed into a single year, modern economic growth would have
begun only at sunrise on the last day o f the year.

2.

M odem economic growth has taken hold in different places at different times.
Since several hundred years ago, when standards o f livin g across countries
varied by no more than a factor o f 2 or 3, there has been a G reat Divergence.
Standards o f livin g across countries today vary by more than a factor o f 60.

3. Incomes in the poorest countries o f the w orld are probably no more than
tw ice as high as average incomes around the w orld a thousand years ago.
4. Since 1870, growth in per capita G D P has averaged about 2 percent per year
in the U nited States. P er capita G D P has risen from about $2,500 in 1870
to more than $37,000 today.
5. Growth rates throughout the world since 1960 show substantial variation, rang
ing from negative growth in many poor countries to rates as high as

6 percent

per year in several newly industrializing countries, most o f which are in Asia.

6.

Growth rates typically change over time. In Germany and Japan, growth picked
up considerably after W orld W ar I I as incomes in these countries converged to
levels in the United Kingdom. Growth rates have slowed down as this conver
gence occurred. B razil exhibited rapid growth in the 1950s and 1960s and slow
growth in the 1980s and 1990s. China showed the opposite pattern.

Review Questions

7. Economic growth, especially in India and China, has dram atically reduced
poverty in the world. In 1960, 2 out o f 3 people in the world lived on less than
$5 per day (in todays prices). By 2000, this number had fallen to only 1 in 10.

Growth Rules
The im portant tools w e w ill u se extensively in the com ing chapters are listed b e
lo w for y o u r convenience.

Calculating a gro w th rate as a percentage change: (yt+i - yt)/yt-

T h e constant gro w th rule: yt = y o (l + gY if y g ro w s at the constant rate g.

The Rule o f 70: if incom e g ro w s at g percent per year, it d ou bles roughly

every 70/g years.

The ratio scale for graphs, w h e re a variable g ro w in g at a constant rate

produces a straight line.

The form u la for com puting average gro w th rates: g = (yt/yo)x/t - 1-

T h e rules for com puting grow th rates o f ratios, products, and exponentials.

1. I f z = x/y, then gz = gx - gy.

2. I f z = ay, then g , = g x + gy.
3. I f 2 =

then gz = agx.

Key C o n c e p ts
constant grow th rule

the G reat D ivergence

convergence

grow th rate

economic grow th

ratio scale

rule for computing

grow th rates
Rule o f 70

Review Questions
1.

W hen and where did sustained economic grow th first begin? H ow much in
equ ality in per capita income w as there throughout the countries o f the world
a thousand years ago? H ow much is there today?

2.

How much richer is the typical 40-year-old today than the typical 40-yearold 35 years ago in the U nited States? W h at about in South K orea or China?

3. This question is not addressed in the chapter and in fact is still debated
among economists but it is interesting to think about: W h y do you suppose
growth in livin g standards was virtu a lly nonexistent for thousands o f years?
W hy did this situation change in recent centuries?
4. W hy are the Rule o f 70 and the ratio scale useful tools? H ow do they w ork
together?
5. W hy, and in w hat sense, do the three grow th rates shown in Figure 3.9 add
up?

6.

W hat are some costs and benefits o f economic growth?

59

Worked Exercises

per capita income a century ago when so many o f the goods w e can buy
today w ere not available at any p rice then. Suppose the true growth
rate in the last century was 3% per yea r rather than 2%. W hat would
the level o f per capita income in 1800 have been in this case? Is this
answer plausible?

WORKED EXERCISES
3. Interest on your bank balance:
(a) To calculate your bank balance in any period, we use the formula from the
constant growth rule in equation (3.7) on page 45:
yt = y o d + g Y

Let B, denote the bank balance and r denote the interest rate. Then your bank
balance satisfies
B, = Z?0( l + r f .
With S 0 = $100 and F = 0.01, the bank balances are shown in the second column
o f Table 3.2 below. For example, after 60 years, the bank balance has reached
$182, not quite double the original value (recall that according to the Rule o f 70,
it w ill take 70 years for the bank balance to double i f the interest rate is 1%).
(b) W e use the same formula with
a

6%

= 0.06 to calculate the bank balances with

interest rate. These are shown in the last column o f Table 3.2. Notice that

the Rule o f 70 applies here as well, so the bank balance doubles about every 12
years. (This is w hy those somewhat odd-looking times were chosen, rather than
t = 5, t = 10, etc.) Notice how the seemingly small difference in interest rates
1% versus

6% turns

into enormous differences in your bank balance. A fter 60

years, the balance is nearly $3,300 when the interest rate is

6%.

(c) and (d) Figure 3.10 shows the bank balances on a standard scale and a
ratio scale (also called a logarithmic scale in some spreadsheet programs). On
the standard scale, w e see the data points curve upward, following the
standard pattern o f economic growth. Because the interest rate is constant, the

Table 3.2

B a n k B a la n c e s

Time

Interest
rate
r = 0.01

Interest
rate
r = 0.06

0
1
2
12
24
48
60

100
101
102
113
127
161
182

100
106
112
201
405
1,639
3,299

63

64

Chapter 3: An O verview o f Long-Run Economic Growth

Figure 3.10

B an k B a la n c e s
B an k b a la n c e

B an k b a la n c e

3.500

3,200

3 .0 0 0 -

1,600 -

2.500
800

2.000

400
1.500

200

1,000

100" *

500

>

02

12

24

48

60

02

12

-L

-L

24

48

T im e

60
T im e

(b) and a ratio scale.

(a ) On a standard s c a le -

upward curve turns into a straight line on the ratio scale. This is what you
need to keep in mind when you are making the plot on the ratio scale: i f you
are not using a spreadsheet program, you just draw the straight line and label
the points as in the table.
6. U.S. g ro w th :

To compute the average annual growth rate, we use the formula from equation
(3.9) on page 49:

HS)' 1-

Notice that this formula is derived from the fam iliar expression yt = y0( 1 + g ).
For the period 1870 to 1929, the formula yields a growth rate o f
n 100 \1 /< 1 9 '2 9 - 1 8 7 0 )

- 1 - 0 .0 1 7 7 .

So the growth rate in this initial period averaged 1.77% per year.
For the period 1950 to 2004, the formula yields a growth rate o f
-

/36 880 \

1 /(2 0 0 4 - 1 9 5 0 )

-1 -0 .0 2 1 5 .

So the growth rate in the more recent period averaged 2.15% per year.