Economic Growth and Productivity Chapter 18 Economic Growth and Productivity © OnlineTexts.com p. 1

Economic Growth Economic growth results from an increase in the economy's total output. Economic growth occurs when the production possibilities frontier shifts outward. © OnlineTexts.com p. 2

The Long Run Defined To properly analyze economic growth, we must take a long view. The long run may be a period of 5, 20, or even 100 years. Over the long run, economic growth increases potential output and shifts the Long Run Aggregate Supply (LRAS) curve to the right. © OnlineTexts.com p. 3

The Compounding Effects of Growth Over long periods of time, even small differences in growth rates can lead to huge differences in living standards. © OnlineTexts.com p. 4

Rule of 69 The Rule of 69 illustrates the power of compounded growth. By dividing an economy's per capita growth rate into 69, one can determine the number of years it takes to double the material standard of living. © OnlineTexts.com p. 5

Extensive and Intensive Growth If a nation is already at its production possibilities frontier, then economic growth only occurs when the frontier shifts outward. The production possibilities frontier shifts outward for one of two reasons resources increase (extensive growth) or technology advances (intensive growth). © OnlineTexts.com p. 6

Productivity Growth rates don’t tell us anything about the sources of growth, but measures of productivity can give us this information. Three major productivity measures exist labor productivity capital productivity multifactor productivity © OnlineTexts.com p. 7

Labor Productivity Labor productivity is the amount of output produced by a worker with one hour of labor input. Labor productivity is influenced by changes in capital and technology. © OnlineTexts.com p. 8

Labor Productivity Labor productivity is pro-cyclical: it increases during economic booms and decreases during recessions. This pro-cyclicality is a result of labor hoarding. © OnlineTexts.com p. 9

Labor Productivity Growth The growth rate of labor productivity is the percentage change in labor productivity from year to year. This growth rate represents the growth in output that is not accounted for by an increase in labor input. © OnlineTexts.com p. 10

Labor Productivity and Wages Over the long term, growth in labor productivity leads to rising real wages. If workers on average are producing more goods and services per hour of labor, then firms can compensate them accordingly. Wage increases driven by labor productivity growth are not inflationary. © OnlineTexts.com p. 11

Net Stock of Private Fixed Assets 1980 to 2002 (Billions $) Capital Productivity Net Stock of Private Fixed Assets 1980 to 2002 (Billions $) Year Net Stock Equipment Structures 1980 7,049.0 1,412.3 5,636.8 1990 12,716.9 2,637.7 10,079.2 1995 15,877.7 3,197.5 12,680.2 2000 21,334.6 4,243.6 17,091.0 2001 22,684.6 4,383.5 18,301.1 2002 23,412.9 4,460.5 18,952.4 Capital productivity is the amount of output produced by one unit of capital input. The U.S. capital stock in 2002 was more than $23.4 trillion. © OnlineTexts.com p. 12

Multifactor Productivity Multifactor productivity is the amount of output (Y) produced by all factor inputs. It represents the growth in output not accounted for by increases in labor and capital inputs. What cannot be accounted for by changes in the quantity of resources is attributed to a catch-all category called technological change. © OnlineTexts.com p. 13

Growth Accounting Growth accounting decomposes output growth into three components: labor inputs (L), capital inputs (K), and technology (A). A/A is multifactor productivity growth. © OnlineTexts.com p. 14

Multifactor Productivity Growth Multifactor productivity growth is also pro-cyclical. © OnlineTexts.com p. 15

Sources of Growth in the U.S. What accounts for the U.S. economic growth? An economist named Edward Denison suggests: 50% of growth results from increases in labor and capital inputs 33% of growth results from advances in knowledge 17% of growth results from “other” factors © OnlineTexts.com p. 16

Sources of Knowledge Advancement Some factors that lead to knowledge advancement include: Investment in research and development Education Access to information Dynamic competition as described through the process of creative destruction © OnlineTexts.com p. 17

Policies to Promote Growth Limit the size of budget deficits to reduce crowding out Subsidize education Promote saving and investment (valued-added tax) Reduction of the capital gains tax © OnlineTexts.com p. 18

The Productivity Slowdown Productivity Growth Rates for Selected Years Years Labor Productivity Multifactor Productivity 1947-1973 2.78 1.88 1974-1980 1.44 0.61 1981-1990 1.51 0.32 1991-1995 1.53 0.60 1996-2001 2.50 0.80 Between 1974 and 1995 U.S. productivity growth declined considerably. © OnlineTexts.com p. 19

The Productivity Slowdown Possible reasons for the slowdown Measurement error: Services are a growing part of the U.S. economy and are more difficult to measure. Economist Robert Gordon concluded that, at most, measurement error accounted for one-third of the slowdown. Oil shocks of 1974 and 1979: Oil shocks may have reduced output without an effect on the labor supply. International competition: Import demand surged. © OnlineTexts.com p. 20

Productivity Recovery? Productivity Growth Rates for Selected Years Years Labor Productivity Multifactor Productivity 1947-1973 2.78 1.88 1974-1980 1.44 0.61 1981-1990 1.51 0.32 1991-1995 1.53 0.60 1996-2001 2.50 0.80 Has productivity growth shifted upward since 1995? Perhaps computer technology is leading to higher labor productivity. © OnlineTexts.com p. 21