1. 10 C H A P T E R Prepared by: Fernando Quijano and Yvonn Quijano And modified by Gabriel Martinez The Facts of Growth

2. © 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Olivier Blanchard The Facts of Growth We now turn from the determination of output in the short and medium run— where fluctuations dominate—to the determination of output in the long run— where growth dominates. Growth is the steady increase in aggregate output over time.

3. © 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Olivier Blanchard Growth in Rich Countries Since 1950 U.S. GDP Since 1890 10-1 Aggregate U.S. output has increased by a factor of 43 since 1890. Notice how unimportant recessions are in the long run. The logarithmic scale on the vertical axis allows for the same proportional increase in a variable to be represented by the same distance.

4. © 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Olivier Blanchard Growth in Rich Countries Since 1950 Output per capita equals GDP divided by population. The standard of living depends on the evolution of output per capita –not total output. To compare GDP across countries, we use a common set of prices for all countries. Adjusted real GDP numbers are measures of purchasing power across countries, also called purchasing power parity (PPP) numbers.

5. © 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Olivier Blanchard Growth in Rich Countries Since 1950 Table 10-1 The Evolution of Output per Capita in Five Rich Countries Since 1950 Annual Growth Rate Output per Capita (%) Real Output per Capita (1996 dollars) 1950-19731974-2000 195020002000/1950 France 4.11.65,48921,2823.9 Germany 4.81.74,64221,9104.7 Japan 7.82.41,94022,03911.4 United Kingdom 2.51.97,32121,6473.0 United States 2.21.711,90330,6372.6 Average 4.31.86,25923,5033.7

6. © 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Olivier Blanchard Growth in Rich Countries Since 1950 From the data in table 10-1 we conclude that: 1.The standard of living has increased significantly since 1950. 2.Growth rates of output per capita have decreased since the mid-1970s. 3.There has been convergence, that is, the levels of output per capita across the five countries have become closer over time. 4.The difference between output per capita in the United States versus the other countries is now smaller than it was in the 1950s.

7. © 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Olivier Blanchard Growth in Rich Countries Since 1950 Growth Rate of GDP per Capita Since 1950 versus GDP Per Capita in 1950; OECD countries Countries that had a lower level of output per capita in 1950 have typically grown faster.

8. © 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Olivier Blanchard A Broader Look Across Time and Space From the end of the Roman Empire to roughly 1500, there was essentially no growth of output per capita in Europe. This period of stagnation is often called the Malthusian era. –According to Robert Malthus, any increase in output would lead to a decrease in mortality, leading to an increase in population until output per capita was back at its initial level. From about 1500 to 1700, growth of output per capita turned positive but small. 10-2

9. © 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Olivier Blanchard A Broader Look Across Time and Space Even during the Industrial Revolution, growth rates were not high by current standards. On the scale of human history, therefore, growth of output per capita is a recent phenomenon. Recent economic history looks more like leapfrogging rather than like simply countries catching up to the United States: there have been many world economic leading countries, and they have been overtaken.

10. © 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Olivier Blanchard Looking Across Countries Growth Rate of GDP per Capita 1960-1992, Versus GDP per Capita in 1960 (1992 dollars); 101 countries If we include all of the world’s countries (and not just the OECD), there is no clear relation between the growth rate of output since 1960 and the level of output per capita in 1960. Some countries that were poor in 1960 had high growth rates since then. Others had low (or negative) rates of growth since then.

11. © 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Olivier Blanchard Looking Across Countries Growth Rate of GDP per Capita 1960-1992, Versus GDP per Capita in 1960: OECD, Africa, and Asia Asian countries are converging to OECD levels. There is no evidence of convergence for African countries. The four triangles on the top left corner correspond to the four tigers: Singapore, Taiwan, Hong Kong, and South Korea. All four have had average annual growth rates of GDP per capita in excess of 6% over the last 30 years.

12. © 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Olivier Blanchard A Broader Look Across Time and Space The fast economic growth of the OECD in the 30 years after WWII are is a historical eccentricity. –Maybe the reasons that caused the world to grow slowly in previous centuries is the same reason poor countries don’t grow today. –Finding the reasons that caused the OECD to grow fast in 1945-1973 may explain why the world is growing more slowly today. –The post-WWII growth of non-US OECD countries may be leapfrogging rather than convergence.

13. © 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Olivier Blanchard Thinking About Growth: A Primer To think about the facts presented in the previous sections, we use the framework of analysis developed by Robert Solow, from MIT, in the late 1950s. Particularly: –What determines growth? –What is the role of capital accumulation? –What is the role of technological progress? 10-3

14. © 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Olivier Blanchard The Aggregate Production Function The aggregate production function is a specification of the relation between aggregate output and the inputs in production. Y = aggregate output. K = capital — the sum of all the machines, plants, and office buildings in the economy. buildings in the economy. N = labor — the number of workers in the economy. The function F, tells us how much output is produced for given quantities of capital and labor.

15. © 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Olivier Blanchard The Aggregate Production Function The aggregate production function depends on the state of technology. The higher the state of technology, the higher for a given K and a given N.

16. © 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Olivier Blanchard The Aggregate Production Function TechnologyTechnology –is the body of knowledge available to a civilization (skills, scientific methods and materials) and the organization of the economy (firm and market structure, government structure and laws) for making goods and supplying services. –The production processes (the blueprints, the instruction manuals) that define the range of products and the techniques available to produce them. Economics of Growth Development Economics

17. © 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Olivier Blanchard Returns to Scale and Returns to Factors Constant returns to scale is a property of the economy in which, if the scale of operation is doubled—that is, if the quantities of capital and labor are doubled—then output will also double.  Or more generally,  An increase in scale is an increase in all inputs by the same proportion.

18. © 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Olivier Blanchard Returns to Scale and Returns to Factors What if we increase only 1 input while leaving all others constant? Output may increase, but there may be Decreasing returns to capital: increases in capital lead to smaller and smaller increases in output as the level of capital increases. Decreasing returns to labor: increases in labor, given capital, lead to smaller and smaller increases in output as the level of labor increases.

19. © 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Olivier Blanchard Output per Worker and Capital per Worker Constant returns to scale implies that we can rewrite the aggregate production function as:  The amount of output per worker, Y/N depends on the amount of capital per worker, K/N.  As capital per worker increases, so does output per worker.

20. © 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Olivier Blanchard Output per Worker and Capital per Worker Output and Capital per Worker Increases in capital per worker lead to smaller and smaller increases in output per worker. An increase in capital per worker, K/N, causes a move along the production function.

21. © 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Olivier Blanchard The Sources of Growth The Effects of an Improvement in the State of Technology An improvement in the state of technology shifts the production function up, leading to an increase in output per worker for a given level of capital per worker.

22. © 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Olivier Blanchard The Sources of Growth Growth comes from capital accumulation and from technological progress. Because of decreasing returns to capital, capital accumulation by itself cannot sustain growth.

23. © 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Olivier Blanchard The Sources of Growth The saving rate is the proportion of income that is saved. –A higher saving rate increases the growth of output, although not permanently. –Two countries with different rates of saving will eventually grow at the same rate. –But the country with a higher saving rate will have a higher level of output per capita.

24. © 2003 Prentice Hall Business PublishingMacroeconomics, 3/e Olivier Blanchard The Sources of Growth Sustained growth requires sustained technological progress. –The rate of growth of output per capita is eventually determined by the economy’s rate of technological progress.