1. Chapter 26 Economic growth
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Economic growth
Economic growth is often measured by the rate of change of real GDP,
although this has many deficiencies.
It omits output that is not bought/sold
e.g. leisure, pollution, congestion.
It also neglects income distribution .
So, higher GDP per capita does not necessarily mean greater happiness,
but it helps.
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3. The production function
shows the maximum output that can be produced using specified quantities of inputs, given existing technical knowledge
Output =
f (capital, labour, land, raw materials, technology)
This is to be read as: output is a function of capital, labour, etc.
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Increasing output
Capital
output per worker may increase with capital per worker
Labour
population growth
participation rates
human capital
Land
fixed supply, but quality may be improved
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Increasing output (2)
Raw materials
important distinction between
depletable resources (coal, oil)
renewable resources (timber, fish)
Technical knowledge
inventions, R&D
Economies of scale may reinforce the long-run growth process
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Technical knowledge
The state of technical knowledge changes through time because of:
inventions
embodiment of knowledge in capital
learning by doing
Research and development (R&D)
patent systems address a market failure which otherwise would lead to there being too little R&D.
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7. Growth and accumulation
Suppose Y = A × f(K, L)
i.e. variable inputs capital (K) and labour (L) combine to produce a given output.
A represents technical knowledge.
At very low levels of income, savings may be zero as all resources are needed for consumption.
So capital cannot be created through investment,
and output may not be able to grow through time.
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8. Theories of growth: some key terms
Along a steady-state path
output, capital and labour are all growing at the same rate, so output per worker and capital per worker are constant.
Capital-widening
extends the existing capital per worker to new extra workers.
Capital deepening
raises capital per worker for all workers.
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9. The Solow (neoclassical) growth model
Assume
labour grows at a constant rate n
constant savings ratio s
capital per worker is k; this is constant in the steady state
adding more capital per worker increases output per worker (y)
but with diminishing returns.
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10. The Solow (neoclassical) growth model
y shows output per person y
Per capita output is y*, and output and capital grow with population. y*
nk shows the investment per person that maintains capital per person while labour grows nk k*
In the steady state E, investment is just sufficient to keep capital per person constant at k*. E
sy shows both saving and
investment per person sy
Output per person, y
Capital per person, k
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A higher savings rate y E y* k*
Suppose the original
steady state is at E.
y**
k** F
takes the economy
to a new steady state
at F. nk
s'y
An increase in the
savings ratio to s' sy
Output per person, y
Capital per person
and output per person
have increased ...
Capital per person, k
But y** is constant, and thus the growth rate is unchanged.
Output and labour continue to grow at the rate n.
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12. The convergence hypothesis
… asserts that poor countries will grow more quickly than average, but rich countries will grow more slowly than average.
i.e. poor countries should ‘catch up’
but social and political differences may enable some economies to catch up more effectively than others.
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Convergence?
Ratio of 2 years
1998
2008
East Asian economies such as China and South Korea grew very quickly during the last 30 years.
Bangladesh
Poor
0.3
0.5
1.67
Nigeria
0.42
0.7
1.68
China
0.35
2.17
6.22
Indonesia
0.78
1.35
1.72
Turkey
Middle
3.28
5.71
1.71
S. Korea
6.23
16.8
2.7
Portugal
9.92
17.4
1.75
Spain
Rich
14.84
26.9
1.81
Ireland
15.27
40.9
2.68
Italy
21.83
31.5
1.42 UK
21.23
39.9
1.88
France
27.13
38.2
1.39
USA
29.92
45.2
1.61
Switzerland
46.17
59.4
1.29
Yet convergence cannot be a powerful force in the world, or the very poorest countries would all be growing very rapidly.
Generally, growth seems to be fostered by two conditions: absence of internal strife and openness to the world economy. 13

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Convergence? (2)
The ratio of per capita income in 2008 relative to 1987 is on the horizontal axis, 1987 per capital income on the vertical axis.
1987 per capita income
On average countries that have become rich then grow more slowly.
but individual country performance can depart significantly from this underlying relationship.
Ratio of per capita incomes
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15. Convergence in the future
By 2025, China will have overtaken the USA, and by 2050 will have a significant economic lead. With the fastest population growth and the second largest population to start with, India will overtake the US eventually, but not before 2050.
Source: PwC
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16. Endogenous growth theory
… recognises that there may be significant externalities to capital
Higher capital in one firm increases productivity in other firms.
known as ‘endogenous’ growth theory because it suggests that growth may depend on parameters that can be influenced by private behaviour or public policy
governments should subsidise human and physical capital formation
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17. The costs of economic growth
Malthus, in the 18th century, warned of limits to growth,
but he underestimated the potential impact of technical change.
The price system helps to ensure a proper use of finite resources.
Growth may bring costs
pollution, congestion, poor quality of life,
But lack of growth may impose costs also.
The assessment of the desirable growth rate remains a normative issue.
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Zero growth?
The zero-growth proposal argues that, because higher measured GNP imposes environmental costs, it is best to aim for zero growth of measured GNP.
This fails to distinguish between measured outputs accompanied by social costs and measured outputs without additional social costs. It does not provide the correct incentives.
when there is too much pollution, congestion, environmental damage or stress, the best solution is to provide incentives that directly reduce these phenomena.
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