Chapter 25 Production and Growth

Economic Growth around the World

Productivity and Its Determinants

Productivity Definition : The quantity of goods and services produced from each unit of labour input. OR Productivity refers to the quantity of goods and services that a worker can produce from each hour of work

Misconception about productivity Productivity is not about what you produce but about how efficiently you produce it. Take a small country like Switzerland with a population of 7 million and real GDP per capita is second in rank after US.

Misconception about productivity - It has no military power, no car industry, no computer industry: among many other things, it exports milk, chocolate, drugs, watches and has large tourism and banking sectors Swiss are rich because they produce goods and services with very high productivity

Determinants of Productivity The four determinants of productivity are: (1) physical capital: is the stock of machinery, equipment and structures that are used to produce goods and services, such as – The machinery in oil refineries, steel mills, power plants – Tools used to repair automobiles or to build homes – Office buildings, schools, TV towers, etc.

Determinants of Productivity (2) human capital, is the term used by economists to define the knowledge and skills that working persons in an economy acquire through education, training and experience • Education constitutes the most important element in human capital • Longer and better education of the citizens increase their ability to undertake complex tasks required in the production process • Training usually takes place during working life and in firms • Like physical capital, human capital raises a nation’s capacity to produce goods and services

Determinants of Productivity (3) natural resources are inputs used in production that are provided by nature, such as agricultural land, rivers, mineral deposits, forests, etc. • Natural resources can be divided into two major categories – Renewable: trees, forests, hydroenergy – Nonrenewable: petroleum, coal, other minerals • Having a large natural resource can be an advantage but it does not lead automatically to high productivity • Some rich countries are poor in natural resources (Denmark, Japan, Singapore) while some poor countries are rich in natural resources (Brazil ($11.000 GDP per capita, Iraq($4500 GDP per capita))

Determinants of Productivity (4) technological knowledge, Technological knowledge is the understanding of the best ways to produce goods and services • Technological knowledge is related to but different from basic science • A country may be well advanced in basic science and produce many high-tech products but still have low real GDP per head (Soviet Union and India are good examples) • Producing good wine (France), expensive shoes (Italy), quality cars (Germany) also correspond to advanced technological knowledge • Human capital refers to the resources expended to transmit the technology to the labour force

The Production Function Y = A f(L, K, H, N) xY= A f(xL, xK, xH, xN) If x=2, then 2Y = A f(2L,2K,2H,2N) If x = 1/L, then Y/L = A f(1, K/L, H/L, N/L)

Y = A f(L, K, H, N) Relationship between the quantity of inputs used in production A is available production technology. As technology improves A rises, so economy produce more output from any given combination of inputs.

Y = A f(L, K, H, N) Y denotes the quantity of output, L denotes the quantity of labour K denotes the quantity of physical capital (capital) H denotes the quantity of human capital N denotes the quantity of natural resources.

xY= A f(xL, xK, xH, xN) Constant Returns to scale. If we double all inputs, it causes the amount of output to double as well. So if write the equation when x=2 It becomes : 2Y = A f(2L,2K,2H,2N)

x = 1/L, Useful Implication Production funciton becomes: - Y/L = A f( 1, K/L, H/L, N/L) Y/L is output per worker (measure of productivity) K/L is capital per worker H/L is human capital per worker N/L is natural resources per worker

Productivity or Output per worker (Y/L) Labour Productivity Or Output Per Worker depends on, Available Production Technology, Capital per worker, Human capital per worker, Natural resources per worker,

Natural Resources’ Effect on Productivity Can productivity-driven economic growth continue indefinitely, given that natural resources are limited? When these shortages start to occur, won’t they stop economic growth and, perhaps, even force living standards to fall?

Natural Resources’ Effect on Productivity Technological knowledge makes production more resource- efficient Adjusted price of natural resources tended remain stable or in some cases even fall over long period of time This shows us while supplies may be falling, demands are declining even more rapidly.

Economic Growth Public Policy What can government policies do to increase productivity or raise of standard of living? -By adopting larger, - Capital per person - Human Capital per person - Technological Knowledge

Saving and Investment In order to have larger stock of capital, Save and Invest more today Or Consume less today We will discuss this issue in chapter 26.

Diminishing Returns to Capital Illustrating the Production Function This figure shows how the amount of capital per worker influences the amount of output per worker. Other determinants of output, including human capital, natural resources, and technology, are held constant. The curve becomes flatter as the amount of capital increases because of diminishing returns to capital.

Catch – Up Effect Poorer countries have more to gain than richer countries. Poor countries tend to grow more rapidly than rich ones. This catch-up effect seems to have been important in fast-growing East Asian economies.

Investment from Abroad Foreign Direct Investment (FDI) Foreign Portfolio Investment (FPI) The World Bank (WB) raises funds in advanced countries and uses those funds to make loans in developing countries.

Education Human Capital accumulation raises productivity through education. Human capital has a cost. Many economist believe that human capital is more important than physical capital. Why? Human capital cost, when students are at school They forego the wages that they could earn by working instead. If an educated worker comes up with new and better ways of producing goods and services, her or she adds to the stock of technological knowledge that is availavle to everyone. (that’s why governments are involved in education heavily.

Health and Nutrition Human Capital is also related to health of workers. Improved nutrition will lead to growth in GDP. But How? The causal link between health and wealth runs in both directions. Poor countries are poor in part because their populations are not healthy, and their populations are not healthy in part because they are poor and cannot afford adequate healthcare and nutrition. It is a vicious circle. But this fact opens the possibility of a virtuous circle: Policies that lead to more rapid economic growth would naturally improve health outcomes, which in turn would further promote economic growth.

Property Rights and Political Stability A mining company will not make the effort to mine iron ore if it expects the ore to be stolen. Political Instability hurts property rights and productivity. The company mines the ore only if it is confident that it will benefit from the ore’s subsequent sale. For this reason, courts serve an important role in a market economy: They enforce property rights. Through the criminal justice system, the courts discourage direct theft. a revolutionary government might confiscate the capital of some businesses, as was often true after communist revolutions, domestic residents have less incentive to save, invest, and start new businesses. At the same time, foreigners have less incentive to invest in the country. Even the threat of revolution can act to depress a nation’s standard of living.

Research and Development knowledge is a public good: That is, once one person discovers an idea, the idea enters society’s pool of knowledge The U.S. government has long played a role in the creation. This helps to be very improved on rocket and plane industry.

Population Growth Population growth can decrease productivity by: Diluting the stock of physical and human capital Stretching natural resources too thin. On the other hand, increases in population may take technological progress more rapid, since there are more people around to discover and invent.

Summary Growth rates of real GDP also vary substantially. Productivity, depends on the physical capital, human capital, natural resources, and technological knowledge available to workers. Government policies can try to influence the economy’s growth rate in many ways: by encouraging saving and investment, fostering education, promoting R&D etc.

Summary The accumulation of capital is subject to diminishing returns. Population growth has a variety of effects on economic growth.

Questions 1. )International data show a positive correlation between income per person and the health of the population. Explain how higher income might cause better health outcomes. Explain how better health outcomes might cause higher income. How might the relative importance of your two hypotheses be relevant for public policy?

Questions 2.) International data show a positive correlation between political stability and economic growth. a. Through what mechanism could political stability lead to strong economic growth? b. Through what mechanism could strong economic growth lead to political stability?

Questions 3.) In many developing nations, young women have lower enrollment rates in secondary school than do young men. Describe several ways in which greater educational opportunities for young women could lead to faster economic growth in these countries.

Questions 4.) How does the rate of population growth influence the level of GDP per person?