MCD 2090 Week 3 T32019upload

MCD2090 – Macroeconomics
Week 3
Long-run Economic Growth: Sources and Policies

Chapter 6
COMMONWEALTH OF AUSTRALIA
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Copyright © 2018 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488612527, Hubbard, Macroeconomics 4e 2
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Chapter 6
Long-run
economic
growth: Sources
and policies
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Learning objectives
6.1 Describe global trends in economic growth.
6.2 Use the economic growth model to explain why

economic growth rates differ between countries.
6.3 Discuss the fluctuations in productivity growth in

Australia.
6.4 Explain economic catch-up and discuss why many

poor countries have not experienced rapid economic
growth. Copyright © 2018 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488612527, Hubbard, Macroeconomics 4e 4
Economic growth over time and around the
world
 Significant economic growth did not begin until the
Industrial Revolution.
 Industrial Revolution: The application of mechanical

power to the production of goods, beginning in Britain
around the mid to late 1700s.
 It has been argued that the institutional changes
following the Glorious Revolution, such as
protecting private property rights, was the key
factor in encouraging entrepreneurship and
growth.
world
world
Why do growth rates matter?
An economy that grows too slowly fails to raise living

standards.
People living in economies with low or no economic growth
suffer from starvation and disease, and lack basic facilities,
healthcare and education.
Economies can be grouped into:
 High-income countries (industrialised): e.g. Western

Europe, Japan, the United States, Canada, Australia, New
Zealand, Hong Kong, Singapore, South Korea and
Taiwan.
 Developing countries (poor countries): e.g. most

countries in Asia, Africa and Latin America.
 Newly industrialising countries: e.g. Brazil, China,

India, Malaysia, Mexico, the Philippines and Thailand.
What determines how fast economies grow?
 Economic growth model: A model that
explains changes in real GDP per capita in the
long run.
 Labour productivity: The quantity of goods and
services that can be produced by one worker or
by one hour of work.
 Technological change: The change in the
ability of a firm to produce output with a given
quantity of inputs.
 Human capital: The accumulated knowledge
and skills workers acquire from education and
training or from their life experiences.
Economic growth theories
Economic growth theory Explanation
Malthusian theory Over time technological improvement
by Thomas Malthus lead to population increase and no
impact on income per capita in the long
run.
Classical growth theory (common) Increase in one input holding other inputs
by David Ricardo and technology constant will lead to
Kaya MR diminishing returns.
Solow-swan model or Exogenous growth There is diminishing returns to capital
model and labour, however, increase in
by Robert Solow and Trevor Swan technology will increase economic
growth
Endogenous growth model Explains how technological advancement
By Robert Lucas and Paul Romer takes place and introduce human capital
which has increasing returns
Extension of Endogenous growth model Economic growth is a consequence of
By Joseph Schumpeter innovation and creative destruction
The per-worker production function
 The economic growth model can be illustrated using
the per-worker production function.
 The per-worker production function: The
relationship between real GDP, or output, per hour
worked and capital per hour worked, holding the level
of technology constant.
– L = labour
– K = capital
– Real GDP per hour = Y/L
– Capital per hour worked = K/L
Which is more important for economic growth: More

capital or technological change?
 Technological change helps economies avoid
diminishing returns to capital.
 Technological change includes:
– the replacement of existing capital with more
productive capital.
– reorganising how production takes place.
Technological change
There are three main sources of technological change:

1. Better machinery and equipment.
2. Increases in human capital.
3. Better means of organising and managing
production. (such as improving production)
Technological change: The key to sustaining

economic growth
 Technological change shifts the per-worker
production function upwards.
 In the long run, a country will experience an
increasing standard of living only if it experiences
continuing technological change.
 New growth theory: A model of long-run economic
growth that emphasises that technological change is
influenced by economic incentives, and so is
determined by the working of the market system.
– Developed by economist Paul Romer.
 Romer argued that the accumulation of knowledge
capital is a key determinant of economic growth.
 Government policy can increase the accumulation of

knowledge and capital in three ways:
1. Protecting intellectual property rights with patents and

copyrights.
2. Subsidising research and development.
3. Subsidising education.
 Patent: The exclusive right to a product for
a period of time from the date the product
was invented.
 Copyright: The legal right of the creator of a

book, movie, piece of music or software to
the exclusive right to use the creation during
the creator’s lifetime, plus an additional
period of time for their heirs.
Joseph Schumpeter and creative destruction

 To Schumpeter, the entrepreneur is central to
economic growth:
 ‘The function of entrepreneurs is to reform or
revolutionise the pattern of production by exploiting an
invention or, more generally, an untried technological
possibility for producing new commodities or
producing an old one in a new way.’
Economic growth in Australia
Theories of economic growth can help understand

Australia’s record of economic growth.
 Prior to colonisation: Small, subsistence Aboriginal
population.
 Colonisation (1788) to early 1800s: Small-scale
farming.
 1861 – 1891: Rapid economic growth.
 1890s – 1940: Droughts in the late 1890s, negative
growth during WWI and the Great Depression.
Economic growth and labour productivity in Australia
since 1940
 1940s – mid-1970s: Increases in labour productivity
and economic growth rates.
 Mid-1970s – 1990: Lower economic growth rates;
relatively low growth rates in productivity.
 1991-2005: Mainly continual strong economic growth;
strong productivity growth rates.
 2006 – 2012: Falls in productivity growth rates
(negative for some industries); slower economic growth
after 2007.
What caused the productivity slowdown of the 1970s and
1980s?
 High oil prices? A popular idea, but the productivity slowdown

continued after firms had adjusted to high oil prices, and after
oil prices fell.
 Regulated markets? Economists believe that regulation stifled
competition, innovation and market flexibility, reducing
productivity growth rates.
 Trade protection? Shielding domestic markets from imports
and international competition reduced domestic innovation
and efficiency (will make ppl become lazy), leading to higher
costs, higher prices and slower productivity growth rates.
 Tariff: A tax imposed by the government on imported goods.

Can Australia maintain high rates of productivity
growth?
 Information technology is believed to have increased
productivity from 1990 to 2005.
 Debate is occurring about whether information

technology can continue to make significant
contributions to productivity growth.
 Multifactor productivity: The quantity of goods and

services produced per combined input of labour and
capital.
 However, from 2006 to 2012 productivity growth rates

fell, and at times became negative.
– This can happen during a boom period for a time,

as resources are fixed and diminishing returns
occur as output rises.
– It has, however, led to calls by economists for
renewed investment in infrastructure and further
industrial reforms.
Why isn’t the whole world rich?
Are the developing countries catching up to the

industrialised countries?
 Catch-up: The prediction that the level of GDP per
capita (or income per capita) in poor countries will
grow faster than in rich countries.
 Some poorer countries have experienced rapid growth

rates, but some have not.
Why don’t more low-income countries experience
rapid growth?
 There is no one answer to the question as to why all
countries do not experience economic growth.
 Most economists identify five key factors:
1. Failure to enforce the rule of law.
2. Wars and revolutions.
3. Poor public education and health.
4. Slow technological development.
5. Low rates of saving and investment.
1. Failure to enforce the rule of law
 Property rights: The rights individuals or businesses

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 a country, particularly with respect to
protecting private property and enforcing contracts.
Source: Created from David Dollar and Aart Kraay (2000), ‘Property Rights, Political Rights, and the Development of Poor Countries in the Post-Colonial Period’, World Bank Development
Research Group Working Paper, October.
36
Copyright © 2018 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488612527, Hubbard, Macroeconomics 4e
2. Wars and revolutions
 Many countries that were poor in 1960 have

experienced extended periods of violent changes of
government during the years since.
 Some examples include Afghanistan, Angola, Ethiopia,

the Central African Republic and the Congo.
3. Poor education and health
 Many low-income countries have weak public school

systems, so many workers are unable to read and
write.
 People who are sick work less, and are less
productive when they do work.
4. Slow technological development
 The economic growth model shows the importance of

technological change.
5. Low rates of saving and investment
 The low savings rates in developing countries

contribute to a vicious cycle of poverty.
 If there’s no saving, there’s no money bank can loans, high interest of
loan, less investing and business, no income, no salary, no
consumption, business can’t get income and close
The benefits of globalisation
 Globalisation: The interaction and integration

between businesses, governments and people of
different countries as they become open to foreign
investment and international trade.
 One way for a poor country to break out of the vicious

cycle of low saving and investment and low economic
growth is through foreign investment.
Why isn’t the whole world rich? (MCQ)
Type of foreign investment:
 Foreign direct investment: The ownership of, or

controlling interest in, assets such as factories,
businesses or farms in a foreign country.
 Foreign portfolio investment: The purchase by an

individual or firm of financial securities, such as
shares or bonds, issued in another country.
Is Economic growth good or bad?
 It is undeniable that economic growth has reduced poverty and increased
health, education and many other measures of welfare.
 Criticisms of economic growth include:
– Globalisation undermines distinctive cultures.
– Multinational firms exploit low wages and poor health, safety and
environmental regulations in the developing world. (ex US put the
call center in India, county opening business in low health country
such as Africa, Vietnam, etc)
– Economic growth contributes to global warming, deforestation and
other environmental problems.
 The search for economic growth that is sustainable has come to the
forefront of economic policy in high-income countries, and also in rapidly
developing countries, such as China and India.
Learning objectives
6.1 Describe global trends in economic growth.
6.2 Use the economic growth model to explain why

economic growth rates differ between countries.
6.3 Discuss the fluctuations in productivity growth in

Australia.
6.4 Explain economic catch-up and discuss why many

poor countries have not experienced rapid economic
growth. Copyright © 2018 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781488612527, Hubbard, Macroeconomics 4e 44
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MCD2090 – Macroeconomics

Long-run Economic Growth: Sources and Policies

Digital Image PowerPoint to accompany: cover image: Smartwatch © Voin_Sveta | Shutterstock.com;

6.2 Use the economic growth model to explain why

6.3 Discuss the fluctuations in productivity growth in

6.4 Explain economic catch-up and discuss why many

 Industrial Revolution: The application of mechanical

An economy that grows too slowly fails to raise living

 High-income countries (industrialised): e.g. Western

 Developing countries (poor countries): e.g. most

 Newly industrialising countries: e.g. Brazil, China,

Which is more important for economic growth: More

There are three main sources of technological change:

Technological change: The key to sustaining

 Government policy can increase the accumulation of

1. Protecting intellectual property rights with patents and

2. Subsidising research and development.

 Copyright: The legal right of the creator of a

Joseph Schumpeter and creative destruction

Theories of economic growth can help understand

 High oil prices? A popular idea, but the productivity slowdown

 Tariff: A tax imposed by the government on imported goods.

 Debate is occurring about whether information

 Multifactor productivity: The quantity of goods and

 However, from 2006 to 2012 productivity growth rates

– This can happen during a boom period for a time,

Are the developing countries catching up to the

 Some poorer countries have experienced rapid growth

 Property rights: The rights individuals or businesses

 Rule of law: The ability of a government to enforce

2. Wars and revolutions

 Many countries that were poor in 1960 have

 Some examples include Afghanistan, Angola, Ethiopia,

3. Poor education and health

 Many low-income countries have weak public school

4. Slow technological development

 The economic growth model shows the importance of

5. Low rates of saving and investment

 The low savings rates in developing countries

The benefits of globalisation

 Globalisation: The interaction and integration

 One way for a poor country to break out of the vicious

Type of foreign investment:

 Foreign direct investment: The ownership of, or

 Foreign portfolio investment: The purchase by an

6.2 Use the economic growth model to explain why

6.3 Discuss the fluctuations in productivity growth in

6.4 Explain economic catch-up and discuss why many

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