1. Principles of Macroeconomics Lecture 9 ECONOMIC GROWTH & DEVELOPMENT

2. The World Economy Total GDP (2008): $70T Population (2009 est): 6.8B
GDP per Capita: $10,000
Population Growth: 1.17%
GDP Growth (2008 est.): 3.8%
GDP per capita is probably the best measure of a country’s well being

3. The World Economy Region GDP % of World GDP GDP Per Capita
Real GDP Growth
United States
$14T
20%
$47,000
1.3%
European Union
$15T
21%
$33,000
1.0%
Japan
$4.3T 6%
$34,200
-.4%
China
$7.8T
11%
$6,000
9.8%
India
$3.2T 5%
$2,800
6.6%
Ethiopia
$66.3B
.09%
$800
8.5%
Source: CIA World Factbook

4. The World Economy United States GPD/Capita: $47,000 GDP Growth: 1.3%
Currently, GDP per capita in the US is around 8 times that in China. However, at the current growth rates, that will shrink to a factor of 1.5 over the next two decades!
China
GDP/Capita: $6,000
GDP Growth: 9.8%
United States
GPD/Capita: $47,000
GDP Growth: 1.3%

5. The World Economy
Per Capita Income

6. Economic growth Income GDP/Capita GDP Growth Low $510 6.3% Middle
As a general rule, low income (developing) countries tend to have higher average rates of growth than do high income countries
Income
GDP/Capita
GDP Growth
Low
$510
6.3%
Middle
$2,190
7.0%
High
$32,040
3.2%
The implication here is that eventually, poorer countries should eventually “catch up” to wealthier countries in terms of per capita income – a concept known as “convergence”

7. Economic growth
Some countries, however, don’t fit the normal pattern of development
Zimbabwe
GDP: $2B
GDP Per Capita: $200
GDP Growth: -12.6%
Macau (China)
GDP: $18B
GDP Per Capita: $30,000
GDP Growth: 15%
So, what is Zimbabwe doing wrong? (Or, what is Macau doing right?)
At current rates, Per capita income is Macau will quadruple to $120,000 over the next decade. This will make Macau the wealthiest country in the world. Over the same time period, per capita GDP in Zimbabwe will drop by roughly 75%to $52!!!

8. To understand this, let’s look at the sources of economic growth…
To understand this, let’s look at the sources of economic growth….where does production come from?
“is a function of”
Real GDP
Productivity
Capital Stock
Labor
Real GDP = Constant Dollar (Inflation adjusted) value of all goods and services produced in the United States
Capital Stock = Constant dollar value of private, non-residential fixed assets
Labor = Private Sector Employment
Productivity = Production unaccounted for by capital or labor

9. The World Economy
Growth accounting breaks down GDP growth into growth of the three factors.
Starting with a production function, take the complete derivative…
Change in production
Change in production per unit change in A
Change in A

10. The World Economy
Contributions to growth from capital, labor, and technology vary across time period
Output
5.79
4.10
1.96
2.63
Capital
3.34
4.24
2.10
2.94
Labor
4.46
1.86
1.60
Productivity
1.71
1.28
0.02
0.59
Some facts to notice:
- Real GDP growth is declining over time.
- Capital has been growing faster than labor

11. A better measure of economic well being is per capita GDP, so let us convert variables to per capita terms
Divide both sides by labor to represent our variables in per capita terms
Capital/Labor Ratio
Productivity (Technology)
Per capita output
In general, let us assume lower case letters refer to per capita variables

12. Capital exhibits diminishing marginal productivity – that is as capital relative to labour rises, its contribution to production shrinks

13. Economic Growth

14. Economic Growth

15. Economic Development
Most countries follow the “usual” pattern of development 1
Developing countries have very little capital, but A LOT of labour. Hence, the price of labor is low, the return to capital is very high 2
High returns to capital attract a lot of investment. As the capital stock grows relative to the labour force, output, consumption, and real wages grow while interest rates (returns to capital fall) 3
Eventually, a country “matures” (i.e. reaches its steady state level of capital). At this point, growth can no longer be achieved by investment in capital. Growth must be “knowledge based” – improving productivity! That means technological improvement!
Productivity

16. Economic Development
Developing countries are well below their steady state and, hence should grow faster than developed countries who are at or near their steady states – a concept known as absolute convergence
Examples of Absolute Convergence (Developing Countries)
China (GDP per capita = $6,300, GDP Growth = 9.3%)
Armenia (GDP per capita = $5,300, GDP Growth = 13.9%)
Chad (GDP per capita = $1,800, GDP Growth = 18.0%)
Angola (GDP per capita = $3,200, GDP Growth = 19.1%)
Examples of Absolute Convergence (Mature Countries)
Canada (GDP per capita = $32,900, GDP Growth = 2.9%)
United Kingdom (GDP per capita = $30,900, GDP Growth = 1.7%)
Japan (GDP per capita = $30,700, GDP Growth = 2.4%)
Australia (GDP per capita = $32,000, GDP Growth = 2.6%)

17. Economic Development
Some countries, however, don’t fit the traditional pattern.
Developing Countries with Low Growth
Zimbabwe (GDP per capita = $2,100, GDP Growth = - 7.0%)
Iraq (GDP per capita = $3,400, GDP Growth = - 3.0%)
North Korea (GDP per capita = $1,800, GDP Growth = 1.0%)
Haiti (GDP per capita = $1,600, GDP Growth = 1.5%)
Developed Countries with high Growth
Hong Kong (GDP per capita = $37,400, GDP Growth = 6.9%)
Iceland (GDP per capita = $34,900, GDP Growth = 6.5%)
Singapore (GDP per capita = $29,900, GDP Growth = 5.7%)

18. Economic Development Haiti Argentina
Conditional convergence suggests that every country converges to its own unique steady state. Countries that are close to their unique steady state will grow slowly while those far away will grow rapidly.
Steady State
(Haiti)
High Population Growth (Haiti)
Low Population Growth (Argentina)
Haiti
Population Growth: 2.3%
GDP/Capita: $1,600
GDP Growth: -1.5%
Argentina
Population Growth: .96%
GDP/Capita: $13,700
GDP Growth: 8.7%
(Argentina)
Haiti is currently ABOVE its steady state (GDP per capita is falling due to a high population growth rate
Argentina, with its low population growth is well below its steady state growing rapidly towards it

19. Economic Development Zimbabwe Hong Kong
GDP/Capita: $2,100
GDP Growth: -7%
Investment Rate (%0f GDP): 7%
High Savings Rate (Hong Kong)
Hong Kong
GDP/Capita: $37,400
GDP Growth: 6.9%
Investment Rate (% of GDP): 21.2%
Low Savings Rate (Zimbabwe)
Steady State
(Zimbabwe)
Steady State
(Hong Kong)
Hong Kong, with its high investment rate is well below its steady state growing rapidly towards it
Zimbabwe is currently ABOVE its steady state (GDP per capita is falling due to low investment rate

20. Economic Development France USA
GDP/Capita: $30,000
GDP Growth: 1.6%
Government (%0f GDP): 55%
Small Government (US)
Large Government (France)
USA
GDP/Capita: $42,000
GDP Growth: 3.5%
Government (% of GDP): 18%
Steady State
(France)
Steady State
(USA)
The smaller government of the US increases the steady state and, hence, economic growth
France has a lower steady state due to its larger public sector. Even though its per capita income is lower than the US, its growth is slower

21. Economic Development Suggestions for growth
High income countries with low growth are at or near their steady state. Policies that increase capital investment will not be useful due to the diminishing marginal product of capital.
- Consider investments in technology and human capital to increase your steady state.
- Consider limiting the size of your government to shift resources to more productive uses (efficiency vs. equity)
Low income countries with low growth either have a low steady state or are having trouble reaching their steady state
- Consider policies to lower your population growth.
- Try to increase your pool of savings (open up to international capital markets)
- Policies aimed at capital formation (property rights, tax credits, etc).

22. Helpful Reading
Economics. Samuelson, & Nordhaus (2005) Ch