ECON 100 Lecture 22 Wednesday, April 30

Midterm Exam #2 Friday, May 16, 6:30 P.M.

Production and Growth

Questions What are the facts about living standards and growth rates around the world? What is productivity and why does it matter for living standards? What determines productivity and its growth rate? What can governments do to raise productivity? How can public policy affect growth and living standards?

Q1, facts, summarized… Economic prosperity, (measured by per capita GDP), varies a lot across countries. The per capita incomes in rich countries are 40 – 50 times that in the poor countries. Per capita GDP growth rates (adjusted for inflation) also vary a lot across countries.

Incomes and Growth Around the World GDP per capita, 2009 Growth rate, 1970–2009 China $6,828 7.4% Singapore $50,633 4.7% India $3,296 3.3% Japan $32,418 2.2% Spain $32,150 2.1% Israel $27,656 Colombia $8,959 1.9% United States $45,989 1.8% Canada $37,808 1.7% Philippines $3,542 1.3% Rwanda $1,136 1.1% New Zealand $28,993 Argentina $14,538 1.0% Saudi Arabia $23,480 0.6% Chad $1,300 0.4% FACT 1: Big differences in living standards around the world. 6

Incomes and Growth Around the World GDP per capita, 2009 Growth rate, 1970–2009 China $6,828 7.4% Singapore $50,633 4.7% India $3,296 3.3% Japan $32,418 2.2% Spain $32,150 2.1% Israel $27,656 Colombia $8,959 1.9% United States $45,989 1.8% Canada $37,808 1.7% Philippines $3,542 1.3% Rwanda $1,136 1.1% New Zealand $28,993 Argentina $14,538 1.0% Saudi Arabia $23,480 0.6% Chad $1,300 0.4% FACT 2: Great variation in growth rates across countries. Average growth rate over a 40 year period! 7

Growth Rates and the Rule of 70 Growth rate from one year to the next

Per capita GDP grows at the rate of 2.5% every year. How many years are needed for the per capita GDP to double? Say from $10,000 to $20,000?

Growth Rates and the Rule of 70 If we assume that the growth rate is constant, then

Per capita GDP grows at the rate of 2.5% every year. How many years are needed for the per capita GDP to double? Say from $10,000 to $20,000? 70/2.5 = 28 years!

Now Per capita GDP grows at the rate of 3% every year. How many years are needed for the per capita GDP to double? Say from $10,000 to $20,000? 70/3 = 23 years!

Growth Rates and the Rule of 70 If per capita GDP grows at 7%, then it doubles every 10 years. If per capita GDP grows at 2%, then it doubles every 35 years.

Growth Rates and the Rule of 70 If real GDP per capita doubles every 10 years, most people in the country see significant increases in their living standards over the course of their lives. If real GDP per capita doubles only every 100 years, then the increase in living standard is much lower.

Questions What is productivity and why does it matter for living standards?

Productivity A country’s standard of living depend on its ability to produce goods and services. This ability depends on productivity. Productivity is defined as the average quantity of goods and services produced per unit of labor input. Y = real GDP = quantity of output produced L = quantity of labor So productivity = Y/L (output per worker)

Why Productivity Is So Important When a nation’s workers are very productive, real GDP is large and incomes are high. When productivity grows rapidly, so do living standards. 17

Imagine a very advanced economy where the productivity level is so high that…

The Universal Replicator The Universal Replicator is a machine that can replicate any physical good.

The Universal Replicator (UR) Example: If a car is put into the Universal Replicator, the machine will create an exact working duplicate at the touch of a button. The UR will work on any non-living object. No replication of humans. (or live animals) Assume that this technology is widely used in the country by all producers. No one has a monopoly of the UR!

The Universal Replicator (UR) What impact will the UR have on the economy? What jobs will not be needed? What kinds of jobs will still be necessary? What will happen to the price of goods? What benefits do you see? What kinds of problems do you expect?

Of course, the Universal Replicator doesn’t really exist but…

technological change has had very similar effects technological change has had very similar effects. The long-term advances in agriculture: Two hundred years ago, 80% of the U.S. labor force worked in farming. Today, farming accounts for only 2% of jobs. Agricultural production has increased tremendously and food prices have decreased substantially.

Manufacturing has followed a similar, but less extreme path Manufacturing has followed a similar, but less extreme path. Fewer workers now produce more goods (which means lower costs and lower prices).

As agricultural and manufacturing employment decline, more workers find employment in the service sector. Lower prices for agricultural and manufactured goods mean services become relatively expensive. Many public issues, such as health care, education, and police protection, are affected by this increase in the relative cost of services.

Like the Universal Replicator, technological progress increases material well-being. But questions remain: What happens to displaced workers? What happens to the distribution of income? How are by-products, wastes, and pollution handled?

What determines productivity and its growth rate? Now back to What determines productivity and its growth rate? 27

Questions What determines productivity and its growth rate?

Physical Capital Per Worker The stock of equipment (tools and machinery) and structures (buildings) used to produce goods service is called [physical] capital, denoted K. K/L = capital per worker. Productivity is higher when the average worker has more capital (machines, equipment, etc.). i.e., an increase in K/L causes an increase in Y/L. 29

Human Capital Per Worker Human capital (H): the knowledge and skills workers get through education, training, and experience. H/L = the average worker’s human capital Productivity is higher when the average worker has more human capital (education, skills, training, etc.). i.e., an increase in H/L causes an increase in Y/L. 30

Natural Resources Per Worker Natural resources (N): the inputs into production that nature provides, e.g., land, mineral deposits Some countries are rich because they have abundant natural resources (e.g., Saudi Arabia has lots of oil). But countries need not have much N to be rich (e.g., Japan imports the N it needs). 31

Technological Knowledge Technological knowledge: society’s understanding of the best ways to produce goods and services. Technological progress does not only mean a faster computer, a higher-definition TV, or a smaller cell phone. It means any advance in knowledge that increases productivity (allows society to get more output from its resources). e.g., Henry Ford and the assembly line. 32

Tech. Knowledge vs. Human Capital Technological knowledge = society’s understanding of how to produce goods and services. Human capital results from the effort people expend to acquire this knowledge. Both are important for productivity. 33

Questions What can governments do to raise productivity? How can public policy affect growth and living standards?

Government Policies That Raise Productivity and Living Standards Encourage saving and investment. More physical capital, this will raise K/L Encourage education and training. More human capital, this will raise H/L Promote research and development. This will improve the available technology

Government Policies That Raise Productivity and Living Standards Establish secure property rights and maintain political stability. Promote free trade. Control population growth. Wonderful book, 23 things they don’t tell you about capitalism, by Ha Joon Chang

Ha-Joon Chang: The net isn't as important as we think The economist and author says the washing machine changed the world more than the internet, a tool we overestimate while ignoring its downsides In his new book, 23 Things They Don't Tell You About Capitalism, Chang debunks many cherished myths about the free market. In one chapter, he says: "The washing machine changed the world more than the internet." http://www.theguardian.com/technology/2010/aug/29/my-bright-idea-ha-joon-chang

End of Part 1

Please do the multiple choice questions now.

Part 2

Capital in the Twenty-first Century, by Thomas Piketty ”a sweeping account of rising inequality” “it could change the way we think about the past two centuries of economic history.” - The Economist

Hardcover: 696 pages Product Dimensions: 9. 6 x 6. 6 x 1 Hardcover: 696 pages Product Dimensions: 9.6 x 6.6 x 1.9 inches Shipping Weight: 2.3 pounds

Thomas Piketty in his office in Paris Thomas Piketty in his office in Paris. Photograph: Ed Alcock for the Guardian

Thomas Piketty teaches at the Paris School of Economics Thomas Piketty teaches at the Paris School of Economics. He has spent nearly two decades studying inequality. He received his PhD in economics at the age of twenty-two. (École Normale Supérieure, 1993.) He taught at M.I.T for two years, after which he returned to Paris. Since then he has “not left Paris, except for a few brief trips.”

Income inequality in the US share of the richest 10% in total income

http://www.newyorker.com/online/blogs/johncassidy/2014/03/piketty-looks-at-inequality-in-six-charts.html?intcid=obnetwork

Europe and the US share of the richest 10% (and 1%) in total wealth Wealth inequality Europe and the US share of the richest 10% (and 1%) in total wealth

In the United States in 2010 … the top 10% of households owned 70% of all the country’s wealth ( ≈ “capital”) The top 1% of households owned 35% of the wealth. The bottom half of households owned five per cent.

When the rate of return on capital—the annual income When the rate of return on capital—the annual income* it generates divided by its market value—is higher than the economy’s growth rate, capital income rises faster than wages and salaries, which don’t grow faster than G.D.P. * dividends, capital gains, interest payments, profits, and rents)

When income generated by capital grows rapidly, the richest families benefit disproportionately. Since 2009, corporate profits, dividend payouts, and the stock market have all risen sharply, but wages have not increased. As a result, according to calculations by Piketty and Saez, almost all of the income growth in the US economy between 2010 and 2012—ninety-five per cent of it—went to the one per cent. http://www.newyorker.com/arts/critics/books/2014/03/31/140331crbo_books_cassidy?currentPage=all

Thomas Piketty The economy’s growth rate has “always” been below the rate of return to capital The 20th century was a historic exception that is unlikely to be repeated. In the coming decades the growth rate will fall back below the rate of return, and the “consequences for the long-term dynamics of the wealth distribution are potentially terrifying.

Read more about the book at the New Yorker website http://www Read more about the book at the New Yorker website http://www.newyorker.com/arts/critics/books/2014/03/31/140331crbo_books_cassidy?currentPage=all at the Guardian http://www.theguardian.com/books/2014/apr/28/thomas-piketty-capital-surprise-bestseller

End of the lecture