1. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 1 of 37 What we learned in our last class Review on supply and demand (graph). Loanable funds market: How do loanable funds supply and demand curves shift. Crowding out effect: Government spending and loanable funds market. Business cycle: four phases. Effects of business cycle: Airline industry, durable goods, interest rate, inflation rate, unemployment rate. American economy became more stable: Services, Government transfer program, Active policy Learning Objective 10.1

2. © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 2 of 24 MySpace Meets the Chinese Economic Miracle 10.1Define economic growth, calculate economic growth rates, and describe global trends in economic growth. 10.2Use the economic growth model to explain why growth rates differ across countries. 10.3Discuss fluctuations in productivity growth in the United States. 10.4Explain economic catch-up and discuss why many poor countries have not experienced rapid economic growth. 10.5Discuss government policies that foster economic growth. Learning Objectives …per capita GDP in China will double every eight years.

3. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 3 of 37 Economic Growth Over Time and Around the World Real GDP per capita (in 2006 dollars): 1,000,000 B.C. : $123 1300 A.D. : $123 2006 A.D. :$10,200 with 6.6 billion people Economic Growth from 1,000,000 B.C. to the Present Learning Objective 10.1

4. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 4 of 37 Learning Objective 10.1 FIGURE 10-1 Average Annual Growth Rates for the World Economy Economic Growth Over Time and Around the World Economic Growth from 1,000,000 B.C. to the Present

5. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 5 of 37 In the long run, small differences in economic growth rates result in big differences in living standards. The process is COMPOUNDING The value of $100 deposit after 50 years: with interest rate of 1.3% : $191 with interest rate of 2.3% : $321 Learning Objective 10.1 Why Do Growth Rates Matter? Growth rates matter because an economy that grows too slowly fails to raise living standards. Economic Growth Over Time and Around the World Small Differences in Growth Rates Are Important

6. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 6 of 37 Learning Objective 10.1 Why Do Growth Rates Matter? Growth rates matter because an economy that grows too slowly fails to raise living standards. An example: Real GDP per capital (2000 dollars) 1950: Argentina: $6,942 France: $5,921 Growth rates: Argentina 0.8%, France: 2.8% 2004: Argentina:$10,939 France: $26,168 Economic Growth Over Time and Around the World

7. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 7 of 37 Learning Objective 10.1 The Benefits of an Earlier Start: Standards of Living in China and Japan Making the Connection Sustained high rates of economic growth have helped Japan attain high living standards. CHINAJAPAN Life expectancy at birth71.9 years82.2 years Infant mortality (per 1,000 live births)233 Percentage of the population surviving on less than $2 per day47%0% Percentage of the population with access to treated water77%100% Percentage of the population with access to improved sanitation44%100% Internet users per 1,000 people73587

8. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 8 of 37 Learning Objective 10.1 FIGURE 10-2 GDP per Capita, 2006 Economic Growth Over Time and Around the World “The Rich Get Richer and... ”

9. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 9 of 37 What Determines How Fast Economies Grow? Economic growth model A model that explains growth rates in real GDP per capita over the long run. Labor productivity The quantity of goods and services that can be produced by one worker or by one hour of work. Increases in Capital per Hour Worked Technological change A change in the quantity of output a firm can produce using a given quantity of inputs. Learning Objective 10.2

10. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 10 of 37 What Determines How Fast Economies Grow? Better machinery and equipment. Increases in human capital. Learning Objective 10.2 There are three main sources of technological change: Human capital The accumulated knowledge and skills that workers acquire from education and training or from their life experiences. Better means of organizing and managing production.

11. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 11 of 37 Per-worker production function The relationship between real GDP per hour worked and capital per hour worked, holding the level of technology constant. Learning Objective 10.2 What Determines How Fast Economies Grow? The Per-Worker Production Function

12. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 12 of 37 Learning Objective 10.2 FIGURE 10-3 The Per-Worker Production Function What Determines How Fast Economies Grow? The Per-Worker Production Function

13. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 13 of 37 Learning Objective 10.2 Technological change helps economies avoid diminishing returns to capital. What Determines How Fast Economies Grow? Which Is More Important for Economic Growth: More Capital or Technological Change?

14. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 14 of 37 Learning Objective 10.2 FIGURE 10-4 Technological Change Increases Output per Hour Worked What Determines How Fast Economies Grow? Technological Change: The Key to Sustaining Economic Growth

15. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 15 of 37 Learning Objective 10.2 Why Did the Soviet Union’s Economy Fail? Making the Connection The fall of the Berlin Wall in 1989 symbolized the failure of Communism.

16. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 16 of 37 Solved Problem 10-2 Using the Economic Growth Model to Analyze the Failure of the Soviet Union’s Economy Learning Objective 10.2

17. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 17 of 37 Learning Objective 10.2 New growth theory A model of long-run economic growth which emphasizes that technological change is influenced by economic incentives and so is determined by the working of the market system. Key determinant: Knowledge capital Physical capital: diminishing return Knowledge capital: increasing return at the level of the economy!! Free ride: Transistor technology developed by Bell laboratory in 1950 What Determines How Fast Economies Grow? New Growth Theory

18. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 18 of 37 Learning Objective 10.2 Protecting intellectual property with patents and copyrights. Patent The exclusive right to a product for a period of 20 years from the date the product is invented. Subsidizing research and development. Subsidizing education. What Determines How Fast Economies Grow? New Growth Theory Government policy can help increase the accumulation of knowledge capital in three ways:

19. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 19 of 37 What we learned in our last class Learning Objective 10.1 The world economy grew much faster in last century than before. Small difference in growth rates matters a lot! Compounding process. France vs. Argentina Gap between rich and poor countries exists What determines the speed of economic growth? Growth model Technological change and capital per hour worked Main sources of technological change

20. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 20 of 37 What we learned in our last class Learning Objective 10.1 Technological change is more important than captial per hour worked Per-worker production function The key to sustain economic growth an example: Soviet Union New growth theory Knowledge capital is crucial to technological change Knowledge capital is influenced and determined by market system Government can do something to help increase knowledge capital !!

21. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 21 of 37 Learning Objective 10.3 FIGURE 10-5 Average Annual Growth Rates in Real GDP per Hour Worked in the United States Economic Growth in the United States Economic Growth in the United States since 1950: Fast, Then Slow, Then Fast Again

22. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 22 of 37 Measurement problems High oil prices A decline in labor quality Learning Objective 10.3 Was It a Measurement Problem? Was It the Effect of High Oil Prices? Was It the Declining Quality of Labor? The Productivity Slowdown Affected All Industrial Countries Economic Growth in the United States What Caused the Productivity Slowdown of 1973–1994?

23. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 23 of 37 Learning Objective 10.3 Why Has Productivity Growth Been Faster in the United States than in Other Countries? FIGURE 10-6 Productivity Growth in the Leading Industrial Economies, 1996–2006 Economic Growth in the United States The Productivity Boom: Are We in a “New Economy”?

24. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 24 of 37 Why Isn’t the Whole World Rich? Catch-up The prediction that the level of GDP per capita (or income per capita) in poor countries will grow faster than in rich countries. Intuition: Diminishing return Learning Objective 10.4

25. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 25 of 37 Why Isn’t the Whole World Rich? Learning Objective 10.4 FIGURE 10-7 The Catch-up Predicted by the Economic Growth Model Catch-up: Sometimes, but Not Always

26. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 26 of 37 Learning Objective 10.4 FIGURE 10-8 There Has Been Catch-up among Industrial Countries Catch-up Among the Industrial Countries Why Isn’t the Whole World Rich? Catch-up: Sometimes, but Not Always

27. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 27 of 37 Learning Objective 10.4 FIGURE 10-9 Most of the World Hasn’t Been Catching Up Are the Developing Countries Catching Up to the Industrial Countries? Why Isn’t the Whole World Rich? Catch-up: Sometimes, but Not Always

28. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 28 of 37 Solved Problem 10-4 The Economic Growth Model’s Prediction of Catch-up Learning Objective 10.4 COUNTRY REAL GDP PER CAPITA IN 1960 (2000 DOLLARS) ANNUAL GROWTH IN REAL GDP PER CAPITA, 1960–2004 Taiwan$1,4436.26% Tunisia2,1023.13 Brazil2,6432.36 Algeria3,8431.04 Argentina7,8380.76 COUNTRY REAL GDP PER CAPITA IN 1960 (2000 DOLLARS) ANNUAL GROWTH IN REAL GDP PER CAPITA, 1960–2004 Japan$4,5093.94% Italy7,1672.70 France8,5312.58 United Kingdom10,3232.19

29. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 29 of 37 Why Isn’t the Whole World Rich? Learning Objective 10.4 Why Don’t More Low-Income Countries Experience Rapid Growth? Property rights The rights individuals or firms have to the exclusive use of their property, including the right to buy or sell it. Failure to Enforce the Rule of Law Rule of law The ability of a government to enforce the laws of the country, particularly with respect to protecting private property and enforcing contracts.

30. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 30 of 37 Learning Objective 10.4 Failure to Enforce the Rule of Law FIGURE 10-10 The Rule of Law and Growth Why Isn’t the Whole World Rich? Why Don’t More Low-Income Countries Experience Rapid Growth?

31. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 31 of 37 Learning Objective 10.4 Wars and Revolutions Why Isn’t the Whole World Rich? Why Don’t More Low-Income Countries Experience Rapid Growth? Wars have made it impossible for countries such as Afghanistan, Angola, Ethiopia, the Central African Republic and the Congo to accumulate capital or adopt new technologies.

32. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 32 of 37 Learning Objective 10.4 Poor Public Education and Health Low Rates of Saving and Investment Why Isn’t the Whole World Rich? Why Don’t More Low-Income Countries Experience Rapid Growth? Many low-income countries have weak public school systems, so many workers are unable to read and write. People who are sick work less and are less productive when they do work. The low savings rates in developing countries contribute to a vicious cycle of poverty.

33. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 33 of 37 Why Isn’t the Whole World Rich? Learning Objective 10.4 The Benefits of Globalization Foreign portfolio investment The purchase by an individual or a firm of stock or bonds issued in another country. Globalization The process of countries becoming more open to foreign trade and investment. Foreign direct investment (FDI) The purchase or building by a corporation of a facility in a foreign country.

34. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 34 of 37 Why Isn’t the Whole World Rich? Learning Objective 10.4 The Benefits of Globalization FIGURE 10-11 Globalization and Growth

35. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 35 of 37 Growth Policies Learning Objective 10.5 Enhancing Property Rights and the Rule of Law Improving Health and Education Policies with Respect to Technology Policies with Respect to Saving and Investment Is Economic Growth Good or Bad? We have seen that even small differences in growth rates compounded over the years can lead to major differences in standards of living. Therefore, there is potentially a very high payoff to government policies that increase growth rates.

36. Chapter 10: Long-Run Economic Growth: Sources and Policies © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 36 of 37 An Inside LOOK Entrepreneurship and Sustained Economic Growth in Europe Feeling Brighter Figure 1. To increase output per worker during the aftermath of World War II, Europe increased capital per worker. Figure 2. To increase output per worker today, Europe must find new and innovative ways to produce.