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CHAPTER 10

CHAPTER10

The Facts
of Growth

Prepared by:
Fernando Quijano and Yvonn Quijano

2006 Prentice Hall Business Publishing

Macroeconomics, 4/e

Olivier

Chapter 10: The Facts of Growth

The Facts of Growth

We now turn from the determination of output in


the short and medium runwhere fluctuations
dominateto the determination of output in the
long runwhere growth dominates.
Growth is the steady increase in aggregate
output over time.

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Chapter 10: The Facts of Growth

10-1

Growth in Rich
Countries Since 1950
Figure 10 - 1
U.S. GDP Since 1890

Aggregate U.S.
output has increased
by a factor of 39
since 1890.

The logarithmic scale on the vertical axis allows


for the same proportional increase in a variable
to be represented by the same distance.

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Chapter 10: The Facts of Growth

Growth in Rich
Countries Since 1950
Output per capita equals GDP divided by
population.
The standard of living depends on the evolution
of output per capita, not total output.
To compare GDP across countries, we use a
common set of prices for all countries. Adjusted
real GDP numbers are measures of purchasing
power across countries, also called purchasing
power parity (PPP) numbers.

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Chapter 10: The Facts of Growth

Growth in Rich
Countries Since 1950
The straightforward method of taking a countrys
GDP expressed in that countrys currency, and
then using the current exchange rate to express
it in terms of dollars does not always work for two
reasons:
First, exchange rates can vary a lot.
The second reason goes beyond fluctuations
in exchange rates. In general, the lower a
countrys output per capita, the lower the
prices of food and basic services in that
country.

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Chapter 10: The Facts of Growth

Growth in Rich
Countries Since 1950
Table 10-1 The Evolution of Output per Capita in Five Rich Countries
Since 1950
Annual Growth Rate
Output per Capita (%)

Real Output per Capita


(1996 dollars)

1950-1973

1974-2000

1950

2000

France

4.0

1.8

5,519

22,371

4.1

Japan

7.4

2.3

2,417

24,671

10.2

United Kingdom

2.4

1.8

7,641

22,188

2.9

United States

2.4

2.1

10,601

33,308

3.1

Average

4.1

2.0

6,544

25,634

3.9

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Chapter 10: The Facts of Growth

Growth in Rich
Countries Since 1950
From the data in table 10-1 we conclude that:
The standard of living has increased
significantly since 1950.
Growth rates of output per capita have
decreased since the mid-1970s.
There has been convergence, that is, the
levels of output per capita across the five
countries have become closer over time.
The Construction of PPP
Numbers
The construction of variables across countries using
a common set of prices underlies PPP estimates.

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Chapter 10: The Facts of Growth

The Large Increase in the Standard


of Living Since 1950
Real output per capita has increased by a factor
of 3.1 since 1950 in the United States, by a factor
of 4.1 in France, and by a factor of 10.2 in Japan.
These numbers show what is sometimes called
the force of compounding.

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Chapter 10: The Facts of Growth

The Decrease in Growth Rates


Since the Mid-1970s
A very useful rule is the rule of 70. If a variable
grows at x% a year, then it will take
approximately 70/x years for the variable to
double.
At a growth rate of 4.1% per year the average
growth rate across the countries from Table 10-1
from 1950 to 1973 it takes only 16 years for the
standard of living to double.
At a growth rate of 2.0% per year the average
from 1973 to 2000 it takes 35 years, more than
twice as long.

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Chapter 10: The Facts of Growth

The Convergence of
Output per Capita
Figure 10 - 1
Growth Rate of GDP
per Capita Since
1950 Versus GDP
per Capita in 1950;
OECD Countries

Countries with lower


levels of output per
capita in 1950 have
typically grown faster.

The convergence of levels of output per capita


across countries is not specific to the four
countries we are looking at, it also extends to the
set of OECD countries.

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Chapter 10: The Facts of Growth

10-2

A Broader Look Across


Time and Space

You should remember three basic facts about


growth in rich countries since 1950:
The large increase in the standard of living
The decrease in growth since the mid-1970s
Convergence of output per capita
These are the three facts we shall keep in mind and
try to explain in the following chapters.

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Chapter 10: The Facts of Growth

Looking Across Two Millennia

There is agreement among economic historians


about the main economic evolutions over the last
2,000 years:
From the end of the Roman Empire to roughly
year 1500, there was essentially no growth of
output per capita in Europe.
From about 1500 to 1700, growth of output
per capita turned positive, about 0.1% per
year
Even during the Industrial Revolution, growth
rates were not high by current standards.
On the scale of human history, the growth of
output per capita is a recent phenomenon.

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Chapter 10: The Facts of Growth

Looking Across Two Millennia

Since 1870, the United States has been the


worlds economic leader. However, if history is
any guide, the United States may not remain the
lead forever. History looks more like
leapfrogging (in which countries get close to the
leader and then overtake it) than like
convergence (in which the race becomes closer
and closer).

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Chapter 10: The Facts of Growth

Looking Across Countries

Figure 10 - 3
Growth Rate of GDP
per Capita 1960-1990,
Versus GDP per
Capita in 1960 (1996
dollars); 99 countries

There is no clear
relation between the
growth rate of output
since 1960 and the
level of output per
capita in 1960.

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Chapter 10: The Facts of Growth

Looking Across Countries

Figure 10 - 4
Growth Rate of GDP
per Capita 1960-1990,
Versus GDP per
Capita in 1960:
OECD, Africa, and
Asia

Asian countries are


converging to OECD
levels. There is no
evidence of
convergence for
African countries.
The four triangles on the top left corner correspond to the four tigers:
Singapore, Taiwan, Hong Kong, and South Korea. All four have had average
annual growth rates of GDP per capita in excess of 5% over the last 30 years.

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Chapter 10: The Facts of Growth

Looking Across Countries

Lets review the three basic facts discussed


earlier for the OECD:
Growth is not a historical necessity.
The convergence of output per capita in many
OECD countries toward the U.S. level may
well be the prelude to leapfrogging, a stage
when output per capita in one or more
countries increases above output per capita in
the United States.
Finally, in a longer historical perspective, it is
not so much the lower growth since 1973 in
the OECD that is unusual.

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Chapter 10: The Facts of Growth

10-3

Thinking About
Growth: A Primer

To think about the facts presented in the previous


sections, we use the framework of analysis
developed by Robert Solow, from MIT, in the late
1950s. Particularly:
What determines growth?
What is the role of capital accumulation?
What is the role of technological progress?

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Chapter 10: The Facts of Growth

Growth and Happiness

Figure 1
Happiness and
Output per
Capita Across
Countries

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Chapter 10: The Facts of Growth

Growth and Happiness

Economists take for


granted that higher
output per capita
means higher utility
and increased
happiness. The
evidence on direct
measures of
happiness, however,
points to a more
complex picture.

Table 1

Distribution of Happiness in the


United States Over Time (Percent)

1975

1996

Very happy

32

31

Pretty happy

55

58

Not too happy

13

11

Table 2
Income Level

Distribution of Happiness in the


United States Across Income Groups
(Percent)
Top Quarter

Bottom Quarter

Very happy

37

16

Pretty happy

57

53

Not too happy

31

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Chapter 10: The Facts of Growth

The Aggregate Production Function

The aggregate production function is a


specification of the relation between aggregate
output and the inputs in production.

Y F (K ,N )
Y = aggregate output.
K = capitalthe sum of all the machines, plants,
and office buildings in the economy.
N = laborthe number of workers in the
economy.
The function F, tells us how much output is
produced for given quantities of capital and labor.

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Chapter 10: The Facts of Growth

The Aggregate Production Function

The aggregate production function depends on


the state of technology. The higher the state of
technology, the higher
for a given K and a given N.
Y F (K ,N )
The state of technology is a set of blue prints
defining the range of products and the
techniques available to produce them.

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Chapter 10: The Facts of Growth

Returns to Scale and


Returns to Factors
Constant returns to scale is a property of the
economy in which, if the scale of operation is
doubledthat is, if the quantities of capital and
labor are doubledthen output will also double.

2 Y F ( 2 K ,2 N )
Or more generally, for any number

x,

xY F (xK ,xN )

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Chapter 10: The Facts of Growth

Returns to Scale and


Returns to Factors
Decreasing returns to capital refers to the
property that increases in capital lead to smaller
and smaller increases in output as the level of
capital increases.
Decreasing returns to labor refers to the
property that increases in labor, given capital,
lead to smaller and smaller increases in output
as the level of labor increases.

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Chapter 10: The Facts of Growth

Output per Worker and


Capital per Worker
Constant returns to scale implies that we can
rewrite the aggregate production function as:

Y
K N
K
F
, F
,1

N
N N
N
The amount of output per worker, Y/N depends
on the amount of capital per worker, K/N.
As capital per worker increases, so does output
per worker.

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Chapter 10: The Facts of Growth

Output per Worker and


Capital per Worker
Figure 10 - 5
Output and Capital
per Worker

Increases in capital
per worker lead to
smaller and smaller
increases in output per
worker.

An increase in capital per worker, K/N, causes a


move along the production function.

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Chapter 10: The Facts of Growth

The Sources of Growth

Figure 10 - 6
The Effects of an
Improvement in the
State of Technology

An improvement in the
state of technology
shifts the production
function up, leading to
an increase in output
per worker for a given
level of capital per
worker.

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Chapter 10: The Facts of Growth

The Sources of Growth

Y
K N
K
F
, F
,1
N N
N
N

Using the above equation, we can now determine


where growth comes from:
Increases in output per worker (Y/N) can
come from increases in capital per worker
(K/N).
Or they can come from improvements in the
state of technology that shift the production
function, F, and lead to more output per
worker given capital per worker.

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Chapter 10: The Facts of Growth

The Sources of Growth

Y
K N
K
F
, F
,1
N N
N
N

Growth comes from capital accumulation and


from technological progress.
Because of decreasing returns to capital, capital
accumulation by itself cannot sustain growth.

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Chapter 10: The Facts of Growth

The Sources of Growth

We can think of growth as coming from capital


accumulation and from technological progress,
but these two factors play very different roles in
the growth process:
Capital accumulation by itself cannot sustain
growth. Saving rate is the proportion of
income that is saved.
Sustained growth requires sustained
technological progress. The rate of growth of
output per capita is eventually determined by
the economys rate of technological progress.

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Chapter 10: The Facts of Growth

Key Terms

growth
logarithmic scale
output per capita
standard of living
purchasing power, purchasing
power parity (PPP),
convergence
Malthusian era
leapfrogging
four tigers

2006 Prentice Hall Business Publishing

aggregate production function


state of technology
constant returns to scale
decreasing returns to capital
decreasing returns to labor
capital accumulation
technological progress
saving rate

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