7 CHAPTER D YNAMIC P OWER P OINT ™ S LIDES BY S OLINA L INDAHL The Wealth of Nations and Economic Growth

CHAPTER OUTLINE Key Facts about the Wealth of Nations and Economic Growth Understanding the Wealth of Nations Incentives and Institutions For applications, click herehere To Video To Video

Some good blogs and other sites to get the juices flowing: Food for Thought….

SEE THE INVISIBLE HAND Economic growth is a matter of life and death to the 1.8 million children who die of diarrhea each year globally.

B ACK TO Key Facts about the Wealth of Nations and Economic Growth Fact One: GDP per Capita Today Varies Enormously among Nations

B ACK TO Key Facts about the Wealth of Nations and Economic Growth Wealth and Health go Together. Source: Penn World Tables and World Bank Group, World Development Indicators, 2005

B ACK TO Key Facts about the Wealth of Nations and Economic Growth Fact Two: Everyone Used to be Poor

B ACK TO Key Facts about the Wealth of Nations and Economic Growth A Primer on Growth Rates How is economic growth measured? Where y t is per capita real GDP in year t Example: Year real GDP per capita 2008$15, $15,500

B ACK TO The Rule of 70 (The Magic of Compounding) The rule of 70: Example: If real GDP per capita is growing at an annual growth rate of 3.5%, it will double in: The moral? Small improvements in growth add up fast (the power of compounding).

B ACK TO A Little Growth Goes a Long Way

B ACK TO Key Facts about the Wealth of Nations and Economic Growth Fact Three: There are Growth Miracles and Growth Disasters

B ACK TO Understanding the Wealth of Nations The Factors of Production are important Physical capital: Physical capital: the stock of tools including machines, structures, and equipment. Human capital: Human capital: is the productive knowledge and skills that workers acquire through education, training and experience. Technological knowledge: Technological knowledge: knowledge about how the world works that is used to produce goods and services.

B ACK TO What Causes Economic Growth?

B ACK TO Understanding the Wealth of Nations Why do some nations have faster growth than others? Besides factors of production, incentives and institutions matter. Institutions Institutions = “rules of the game” that structure economic incentives. Institutions of Economic Growth 1.Property rights 2.Honest government 3.Political stability 4.A dependable legal system 5.Competitive and open markets

B ACK TO Korea’s Experiment Before division after WWII: similar Culture, physical capital, technology. North Korea became a communist state with a centrally planned economy. South Korea adopted the capitalist free market model.

SEE THE INVISIBLE HAND North and South Korea at night

B ACK TO Institutions 1. Property rights: Provide incentives to work hard. Encourage investment and innovation. Without property rights: Effort is divorced from payment, reducing incentives. Free riders become a problem.

B ACK TO Institutions Free Rider Free Rider = someone who consumes a resources without working or contributing to the resource’s upkeep. China’s “Great Leap Forward”- which introduced farming collectives- reduced incentives million starved. 1978, farmers in Xiaogang met in secret to devise a plan to keep some of their produce. (background photo) Productivity improved so quickly the government allowed the experiment to proceed. Food production increased 50% in 5 years

B ACK TO Institutions 2. Honest Government Property rights are meaningless unless government guarantees property rights. Corruption bleeds resources away from productive entrepreneurs. Corruption takes resources away from more productive government activity.

B ACK TO Corruption and Growth Don’t go Together Source: Penn World Tables and World Bank Group, World Development Indicators, 2005

B ACK TO Corruption Who’s Who List

B ACK TO Institutions 3.Political Stability Changing governments without the rule of law creates uncertainty which leads to less investment in physical and human capital. In many nations civil war, military dictatorship, and anarchy have destroyed the institutions necessary for economic growth. Bullet casings from Liberia’s Civil War: Bad soil for anything to grow.

B ACK TO Institutions 4.Dependable Legal System A good legal system facilitates contracts and protects property from others (including government). Poorly protected property rights can result from too much government or too little government. In India, residents who purchase land have to do so more than once because of lack of proper record keeping.

B ACK TO Institutions 5.Competitive and Open Markets Encourage the efficient organization of resources. One study found: if India used its physical and human capital as efficiently as the U.S., India would be 4x richer than it is today.

B ACK TO Institutions Why do poor countries use their capital inefficiently? Whether inadvertently or not, inefficient and unnecessary regulations: Create monopolies and impede markets Example: until recently in India, it was illegal to produce shirts using large-scale production Economies of scale Economies of scale = the advantages of large-scale production that reduce average cost as quantity increases

B ACK TO Institutions and Growth Miracles Revisited Why did England’s Industrial Revolution bring us:  large scale factories  mass production  the steam engine  the railroad  the beginnings of a consumer society  the first sustained rise in human living standards above subsistence?

B ACK TO Institutions and Growth Miracles Revisited Property rights? England’s geography and Navy helped protect property rights Honest government Growth of Parliament (and religious changes) reduced royal tyranny Political stability Middle class developed from growth A dependable legal system Less corruption as royal and Catholic power is reduced Competitive and open markets England opened itself more to trade