1. 11–1 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Chapter 11 The Economy in the Long Run: An Introduction to Economic Growth

2. 11–2 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Chapter 11: The Economy in the Long Run: An Introduction to Economic Growth An introduction to economic growth Economic growth and potential output Growth rates and differences in living standards Why nations become rich: the crucial role of average labour productivity The costs of economic growth Promoting economic growth Are there limits to growth?

3. 11–3 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Measuring Growth Long-term growth refers to a rise in living standards, not the rise in total GDP Material living standards reflected in GDP per capita The key to rises in GDP per capita is rises in GDP per worker, or labour productivity

4. 11–4 Comparative Growth Rates

5. 11–5 Comparative Growth Rates

6. 11–6 Comparative Growth Rates: Asia

7. 11–7 World Inequality

8. 11–8 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Doubling the Standard of Living The faster the growth rate, the shorter the time it takes to double the standard of living – 36 years at 2% p.a. and only 14.4 years at 5% p.a At 2% p.a., your real income will be four times that of your grandparents Time taken is less than proportional to the growth rate because of the principle of compound interest The ‘Rule of 72’ tells us that the standard of living will double in a period such that this period times the growth rate equals 72

9. 11–9 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Growth Theory and Supply In the long run the economy corrects so that GDP = potential GDP (Y = Y*) Growth theory is concerned with the rise in Y*

10. 11–10 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Constraints on Long-Run Growth Growth in labour or worker productivity Growth in population Growth in worker/population ratio Y/Population = Y/worker x worker/population

11. 11–11 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank When the Population Ages Because a constant or declining population is an ageing one, a reduction in the worker/population ratio is a problem in high-income countries (and will be in China) where population is constant or falling A fall (negative growth rate) in the worker/population ratio reduces the growth rate of Y/population

12. 11–12 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Factors in Labour Productivity Human capital per worker (skills) Physical capital per worker Land and natural resources per worker The level of technology which is reflected in the age of the physical capital stock

13. 11–13 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank The Age of the Capital Stock New machinery embodies the latest technology and is more productive Ironically, Germany and Japan gained a competitive advantage from the devastation of World War II – new equipment

14. 11–14 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Other Factors in Productivity Entrepreneurship and quality of management Political and legal environment: the peaceful settlement of international, political, commercial and employment disputes, and protection of property rights, are essential The social status accorded to productive people as opposed to those who are merely rich or well educated Incentives to effort provided by the taxation and welfare systems

15. 11–15 Capital & Production Per Worker

16. 11–16 Productivity Slowdown

17. 11–17 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Explanations of Slowdown Slowdown may be illusory, because quality improvements are not measured The period immediately following the Great Depression and World War II was one of unusually high productivity growth Time will tell whether productivity growth has resumed with improved information and other technology dating from the late 1990s

18. 11–18 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Costs of Economic Growth Growth raises future consumption possibilities at the expense of current consumption, including leisure For long-term investment projects this involves older persons making sacrifices for younger ones This is because older persons make the sacrifice of saving, while younger ones enjoy the future fruits of that saving

19. 11–19 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Early Growth May Be Painful Growth requires a rise in saving and investment A rise in saving when income and consumption are already low can hurt

20. 11–20 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Policies to Promote Growth Human capital: education, training and research Physical capital: saving and investment Knowledge: research and development Incentives can be given with taxes and subsidies

21. 11–21 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Example of Tax Incentives Accelerated depreciation allows companies to write off their capital expenditures against their taxable income at a faster rate than it wears out Such capital expenditures can include research and development Accelerated depreciation raises the after-tax rate of profit because investors’ capital is returned more quickly

22. 11–22 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Other Policies Sensible regulation which is targeted towards the outcome being sought: no regulation for its own sake Enforcement of property rights Peaceful settlement of disputes Transparent government and justice system Some of these things are absent in poor countries

23. 11–23 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Inflation and Growth Low and predictable inflation helps investment and growth: –By reducing uncertainty –By keeping nominal interest rates low –By maintaining the household incentive to save –By maintaining confidence in money, which maximises the specialisation of labour –By avoiding the social waste of productive people using their time to profit from inflation at the expense of others (negative sum games)

24. 11–24 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Are There Limits to Growth? Individual resources like fossil fuels are finite, but substitutes are being developed through research and development This process of finding substitutes for resources in short supply is more affordable in high-income countries because science is more affordable

25. 11–25 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Growth and the Environment Degradation of the environment is not due to growth of GDP per capita, but is due to mis-pricing of energy sources (such as fossil fuels) and of methods of waste disposal, and population growth Environmental standards tend to be higher in high- income countries because environmental quality is valued more highly in those countries because of their higher income They also have the means to clean up

26. 11–26 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank A Qualification If resources continue to be mis-priced because of defects in the political process, then growth as we have known it may have to be curbed

27. 11–27 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Economic Growth & Population Population growth is lower in high-income countries because people do not have to rely on their children to support them in old age This helps the environment by reducing population density However, as noted earlier, zero or low population growth raises problems for future growth by causing the population to age and the worker/population ratio to fall

28. 11–28 Copyright  2005 McGraw-Hill Australia Pty Ltd PowerPoint® Slides t/a Principles of Macroeconomics by Bernanke, Olekalns and Frank Economic Growth and Health Health is more affordable in high-income countries This raises worker productivity and helps offset the impact of a fall in the worker/population ratio on the future growth rate