MACROECONOMICS

Chapter 3
Long-Run Economic Growth
Comparing Economies Across Time and Space
Income Around the World, 2010
Cross-Country Comparison of Growth Rates
The Source of Long-Run Growth: Labor Productivity
Productivity is output per worker.
• Increasing productivity leads to sustained growth.

Real Case # Growth of US in Twentieth Century

Average annual growth
Population – 1.3 %
Employment- 1.5 %
Real GDP percapita – 1.9%
Share of productivity in real GDP percapita growth – 1.7 % (i.e. 90%)
 Factors Governing Labour Productivity
• Physical capital
# Manufactured resources
# Consists of human-made resources such as buildings and
machines.
# machines and tools improve efficiency and productivity
• Human capital
# is the improvement in labor created by the education and
knowledge embodied in the workforce.
# skilled labour operate modern techniques effectively
• Technology
# is the technical means for the production of goods and
services
# inventions & innovations attribute to productivity
Accounting for Growth: The Aggregate Production Function

The aggregate production function is a hypothetical function

that shows how productivity (real GDP per worker) depends on
the quantities of physical capital per worker and human capital
per worker as well as the state of technology.
Accounting for Growth: The Aggregate Production Function

A Study of Chinese and Indian Economic Growth

• Economists Barry Bosworth and Susan Collins of the
Brookings Institution made a comparative study of Chinese
and Indian economic growth.
• Is the most recent study on aggregate production function
• They used the following aggregate production function:
Accounting for Growth: The Aggregate Production Function

Objective :
to explain why China grew faster than India
Study Period:
between 1978 and 2004.
Findings:
China grows faster than India due to two reasons;
 Physical capital : About half the difference was due to
China’s higher levels of investment spending, which raised
its level of physical capital per worker faster than India’s.
 Technology : The other half was due to faster Chinese
technological progress.
Diminishing Returns to Physical Capital
• An aggregate production function exhibits diminishing
returns to physical capital
• Statement: each successive increase in the amount of
physical capital leads to a smaller increase in productivity.
• Assumption: the amount of human capital and the state of
technology is fixed.
Diminishing Returns to Physical Capital
A hypothetical example: how physical capital per worker
affects productivity, holding human capital and technology
fixed

Physical capital per worker Real GDP per worker

$0 $0

15,000 30,000

30,000 45,000

45,000 55,000
 Physical Capital and Productivity

Real GDP
per
worker

Productivity
$60,00
1. The increase 0 C
in real GDP per
worker becomes B
50,000
smaller . . .

30,000 A

0 $20,000 50,000 80,000

Physical capital per
2. as physical
capital per worker worker (2005
rises. dollars)
 Technological Progress and Productivity Growth
Real GDP per Productivity
worker (constant using 2010
dollars) technology
$120,000

90,000 Rising total

factor
productivity
shifts curve up
Productivity
using 1940
60,000 technology

30,000

0 $20,000 40,000 60,000 80,000

Physical capital per
worker
(constant dollars)
What About Natural Resources?
• In contrast to earlier times, natural resources are a much
less important determinant of productivity than human or
physical capital for the great majority of countries in the
modern world.

• For example, 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.
Why Growth Rates Differ
• A number of factors influence differences among countries in
their growth rates.

1. Differences in Physical Capital Addition

2. Differences in Human Capital Addition
3. Differences in Technological Progress
 Why Growth Rates Differ

1. Differences in Physical Capital Addition

= differences in savings & investment between countries

• In 1960s Japan was fast growing economy with high share of

GDP on investment
• Today China is the fastest growing – invested 38% of GDP in
2010 in building physical capital, while US only 16%
Why Growth Rates Differ
2. Differences in Human Capital Addition
= countries differ in skills & education

Case 1: Human Capital in Latin America and East Asia

Latin America East Asia

1960 2000 1960 2000

Percentage of population with no

37.90% 14.6% 52.50% 19.80%
schooling

Percentage of population with

5.9 19.5 4.4 26.5
high school or above
Human Capital and Catch-Up
Case 2: Human Capital in Argentina & China
Why Growth Rates Differ

3. Differences in Technological Progress

• Spending on R&D
• Capability to develop new technology
• Ability to apply it
 The Role of Government in Promoting Economic Growth
• Infrastructure – physical capital
• build roads, power, ports, IT networks etc.
• even private participation requires Govt. regulations & support
Ex: Ireland Govt. invested heavily in 1980s in telecom
infrastructure & helped private high-tech companies; so in 1990s
its economy took off
• Education – human capital
• Spending on primary and secondary education
Ex: East Asia has more educated than Latin America because Asian
Govts. made education higher priority.
• R & D – technology
• Case: Brazil’s agricultural boom in recent years
• Tropical savanna land was considered as unfit for farming
• Govt. researchers developed crucial technologies
 The Role of Government in Promoting Economic Growth
• Added nutrients to the soil- lime & phosphorus
• Made land productive
• Political Stability & Good Governance
• Political instability like riots, wars drives away investment
• Property Rights
• Good laws, institutions to enforce laws, protect property
• Trustworthy Financial System
• Excessive Govt. Intervention
• 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
• Indian Case: Until 1991 Indian govt. imposed bureaucratic
restrictions on business, bribe officials for approval- led to slow
growth
• Reforms since 1991- more privatisation & higher growth
Success, Disappointment, and Failure
Success, Disappointment, and Failure
• The world economy contains examples of success and failure
in the effort to achieve long-run economic growth.
 East Asian economies have done many things right and
achieved very high growth rates.
 In Latin America, where some important conditions are
lacking, growth has generally been disappointing.
 In Africa, real GDP per capita has declined for several decades,
although there are some signs of progress now.
Success, Disappointment, and Failure
East Asia’s Miracle: A classic case of South Korea
• In 1960 S. Korea was very poor
• Its GDP per capita was less than India
• Grew in 7% + for more than 30 years since 1960
• Today much like an economically advanced economy though
poorer than US or Europe
• Took only 35 years to achieve this growth that required
centuries else where
• High growth rate 1st appeared in S.Korea
• Other East Asian countries: Taiwan, Hong Kong & Singapore,
then spread across the region , notably to China
• Since 1975, whole region increased GDP per capita by 6 % per
year
• It is 3 times America’s historical growth rate
 Success, Disappointment, and Failure
How Have the Asian Countries Achieved High Growth Rates?
Ans: sources of productivity growth have been firing on all
cylinders
• high savings and investment spending rates increased
significantly the amount physical capital per worker
• emphasis on education, permitted rapid improvement in
human capital
• adoption of technological advances from other countries

Convergence hypothesis
• Difference in real GDP per capita among East Asian countries
narrows down over the period of time.
• Countries with lower real GDP per capita have higher growth
rates.
 Success, Disappointment, and Failure
Latin America’s Disappointment
In 1900
• Was not backward region
• Abundant natural resources- minerals & cultivable land
• Attracted millions of migrants from Europe, particularly Argentina
• GDP/capita of Argentina, Uruguay and Brazil were comparable to
advanced countries.
Since 1920
• Growth is disappointing till date
• Argentina has become poorer than Korea
• Reasons for slow growth of Latin America: poor education, political
instability, and irresponsible government policies
In 1980s
• The region was suffering from excessive Govt. intervention
Now
• Only Chile growing rapidly
• For other countries, pulling off economic growth seems to be miracle
 Success, Disappointment, and Failure
Africa’s Troubles
• Very poor
• GDP/capita in sub-Saharan Africa fell 13% from 1980 to 1994
• Since then recovery is very slow
• Ex: Nigeria
Factors
• Political instability, wars killed millions, no productive
investment
• Poor infrastructure— particularly affecting public health &
education
• Lack of legal safeguards to property owners
• have resulted in a catastrophic failure of growth.
Encouragingly, the economic performance since the mid-1990s
has been much better than in preceding years.
 Is World Growth Sustainable?
• Long-run economic growth is sustainable if it can continue in the face of the
limited supply of natural resources and the impact of growth on the
environment.
• Differing views about the impact of limited natural resources on long-run
economic growth turn on the answers to three questions:
1) How large are the supplies of key natural resources?
- Geologists to answer
Some: there is enough untapped resources, particularly oil
Others: difficulty in finding in new oil fields, so gradual decline
2) How effective will technology be at finding alternatives to natural
resources?
- Engineers to answer
There are many alternatives to depleting natural resources
3) Can long-run economic growth continue in the face of resource scarcity?
- Economists to answer
Most: modern economies can find new ways to limited resources as
alternatives.
Scarcity leads to high resource prices, provides incentive to find alternatives.
The Real Price of Oil, 1949-2010
U.S. Oil Consumption and Growth over Time
Economic Growth and the Environment
• Economic growth tends to increase human impact on the
environment.
Best Case: China
Spectacular economic growth in China has brought a
spectacular increase in air pollution
• Burning coal & oil releases carbon dioxide into atmosphere.
• This causes a green house effect on the earth.
• Result: raises planet’s temperature .
• Imposes human & economic costs.
• Climate change may disrupt agriculture.
Climate Change and Growth
Economic Growth and the Environment
Climate Protection
• Limiting the emission of greenhouse will require some
reduction in growth.

• However, the best available estimates suggest that a large

reduction in emissions would require only a modest
reduction in the growth rate.

• There is broad consensus that government action to address

climate change and greenhouse gases should be in the form
of market-based incentives, like a carbon tax or a cap and
trade system.
• It will also require rich and poor countries to come to some
agreement on how the cost of emissions reductions will be
shared.