Chapter Production and Growth 12

Economic Growth Around the World Growth rate of real GDP over time – Measures how rapidly real GDP per person grows over time Is the economy developing and how fast? – Typically use average GDP growth rate over intervals of 5 or more years smooth out short-run fluctuations shows trend, or long-term, rate of growth 2

Table The variety of growth experiences 1 3 CountryPeriodReal GDP per person at beginning of period Real GDP per person at end of period Growth rate (per year) Japan Brazil China Mexico Germany Canada Argentina United States India United Kingdom Indonesia Bangladesh Pakistan 1890– – – – – – – –2006 $1, ,085 2,045 2,224 2,147 3, , $33,150 8,880 7,740 11,410 31,830 34,610 15,390 44,260 3,800 35,580 3,950 2,340 2, %

Productivity: its Role and Determinants Productivity – Quantity of goods and services produced from each unit of labor input (output per unit labor – hours?) – Output per person (per hour) Increases in productivity due to: – Improved technology – “Working smarter” – better educated Why productivity is so important – Key determinant of living standards 4

Productivity: its Role and Determinants How productivity is determined – Physical capital Stock of equipment and structures Used to produce goods and services – Human capital Knowledge and skills that workers acquire through education, training, and experience 5

Productivity: its Role and Determinants How productivity is determined – Natural resources Inputs into the production of goods and services Provided by nature, such as land, rivers, and mineral deposits – Technological knowledge Society’s understanding of the best ways to produce goods and services 6

Real GDP in the United States 2 7 This figure shows quarterly data on real GDP for the U.S. economy since Recessions—periods of falling real GDP—are marked with the shaded vertical bars.

GNP Growth is Not Steady 8

Real GDP (year to year) and Trend Rate of Growth 9

US GDP Growth Rate Since the Great Recession TO REFRESHREFRESH |COMPARE|COMPARE SIGNUPTO:EXPORTDATA|GETFORECASTSIGNUPTO:EXPORTDATA|GETFORECAST TRENDMOVAVGMEANMAXMINTRENDMOVAVGMEANMAXMIN EMBED CHARTEMBED CHART

11

Productivity vs. Compensation Economic Policy Institute 12

13

Income Inequality in Developed Countries Using the Gini Coefficient (> G -> Grtr Inequality) 14

15

16

Economic Growth and Public Policy Saving and investment (in new technology) Raise future productivity – Invest more current resources in the production of capital – Trade-off Devote fewer resources to produce goods and services for current consumption Policy options – Tax cuts for the rich as they save more (>.2) – Savings incentives for all 17

Economic Growth and Public Policy Diminishing returns and the catch-up effect Higher savings rate – More funds available for Investment Investment - > increase in Capital stock – Rising productivity (technological shift) – More rapid growth in GDP Increases current labor force’s productivity 18

The real middle-class challenge - Samuelson 19 CEA found: that inequality isn’t the main cause of sluggish middle-class incomes. It’s poor productivity. Rhetorical solutions: more infrastructure spending; better schools; simpler taxes; more research. Though some policies may be desirable, there’s no guarantee they will improve productivity. Influencing productivity is hard because it depends on so much (management and workers, technology, market behavior, government policies and more).

Economic Growth and Public Policy Diminishing returns and the catch-up effect Diminishing returns – Marginal returns on investment: Benefit (increase in output) from an extra unit of an input of K – Marg return declines as the quantity of the input increases More mature economies – Smaller increases in productivity with Investment than “newer” industrializing economies 20

Figure Output per Worker Illustrating the production function 1 21 Output per Worker 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 When the economy has a low level of capital, an extra unit of capital leads to a large increase in output. 2. When the economy has a high level of capital, an extra unit of capital leads to a small increase in output.

Economic Growth and Public Policy Diminishing returns and the catch-up effect Catch-up effect – Countries that start off poor – Tend to grow more rapidly than countries that start off rich Poor countries – Low productivity – Even small amounts of capital investment Increase workers’ productivity substantially 22

Economic Growth and Public Policy Diminishing returns and the catch-up effect Rich countries – High productivity – Additional capital investment Small effect on productivity Poor countries – Tend to grow faster than rich countries 23

Economic Growth and Public Policy Education – Investment in human capital – Gap between wages of educated and uneducated workers – Opportunity cost: wages forgone – Conveys positive externality Problem for poor countries – Brain drain 24

Economic Growth and Public Policy Health and nutrition – Healthier workers – more productive – The right investments in the health of the population One way for a nation to increase productivity and raise living standards – Historical trends: long-run economic growth Improved health - from better nutrition Taller workers – higher wages – better productivity 25

Economic Growth and Public Policy Health and nutrition – Vicious circle in poor countries Are poor – Because populations are not healthy Populations are not healthy – Because they are poor » Cannot afford better healthcare and nutrition 26

Economic Growth and Public Policy Property rights and political stability Foster economic growth – Protect property rights Ability of people to exercise authority over the resources they own Courts – enforce property rights – Promote political stability 27

Economic Growth and Public Policy Research and development Knowledge – public good – Farming methods – Aerospace research Air Force; NASA – Research grants National Science Foundation National Institutes of Health – Tax breaks – Patent system 28

Economic Growth and Public Policy Population growth Large population – Large labor force – More consumers Stretching natural resources? Diluting the capital stock – High population growth Reduces GDP per worker – Promoting technological progress 29