Chapter 12 Production and Growth

Outline International comparisons of real GDP per capita What is productivity, its determinants, and its impact on economic growth Link between productivity, economic growth and a nation’s public policy

Real GDP per capita and living standards Country Period Real GDP per person at beginning of period (1997 Can $) Real GDP per person at end of period (1997 Can $) Growth rate Per year (%) Japan 1890-1997 1656 32392 2.82 Canada 1870-1997 2616 30261 1.95 China 1900-1997 789 4942 1.91 USA 4413 39784 1.75 India 743 2699 1.34

Living standards

Productivity Productivity is the amount of goods and services produced from each hour of a worker’s time Productivity determines the living standards of a nation as the latter depends on the nation’s ability to produce goods and services Determinants of Productivity: Physical capital Human capital Natural resources Technological knowledge Y=A F(L, K, H, N)

Economic Growth and Public Policy Can public policy raise productivity and living standards? Encourage Savings and Investment Recall that capital is a produced factor of production Tradeoff between capital investment and consumption goods Correlation between growth and investment (reverse causality?) Diminishing returns to capital

Diminishing returns and the catch-up effect Diminishing returns is the property whereby the extra benefit from an extra unit of an input declines as the quantity of input increases In the production process, capital is subject to diminishing returns As a result of diminishing returns to capital: In the LR, higher savings leads to greater accumulation of capital and therefore higher level of productivity and income BUT not to higher growth in productivity and income Catch-up effect is the property whereby countries that start off poor tend to grow more rapidly than countries that start off rich

Economic Growth and Public Policy (contd) Investment from abroad FDI Foreign portfolio investment Foreign investment raises GNP (income) less than it raises GDP (production) Source of state-of -the-art technologies Education- investment in human capital Positive externalities Opportunity cost of schooling is higher in poor countries Brain-drain- negative externality

Economic Growth and Public Policy (contd) Property rights and political stability Coordination of economic activities through market prices Corruption impedes coordinating power of markets Discourages domestic savings and foreign investment Free trade Infant- industry argument Small size of the economy Landlocked countries

Economic Growth and Public Policy (contd) Control of population growth Population growth reduces GDP per capita Huge burden on education system Malthus theory on population growth Raising opportunity cost of additional children Research and Development Knowledge is a public good Tax breaks and patent system encourages R and D

Economic Growth and Public Policy (contd) Cross-country growth studies show that per capita growth is related to : Initial income level of the country Geographic and resource structure of the country Market orientation of the economy National saving rate Is productivity slowdown in industrialized countries a result of slow technological progress?