1. What is Macroeconomics?mbrzez/Makro_II/Economic growth.pdf · Average annual real GDP growth rates Overall growth 1820-70 1870-1913 1913-50 1950-73 1973-2001 1820-2001 Belgium

Economic Growth

M.Brzoza-Brzezina:

Macroeconomics II - Economic

growth

2

Outline

1. Stylized facts about growth

2. The Solow growth model

3. Sources of economic growth

This lecture follows chapters 3 and

(partly) 18 of the textbook.

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1. Stylized facts about growth

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Stylized fact #1

Most economies grow over time, both in

aggregate and per capita terms.

Average annual real GDP growth rates

Overall

growth

1820-70 1870-1913 1913-50 1950-73 1973-2001 1820-2001

Belgium 2.2 2.0 1.0 4.1 2.1 2.1

Denmark 1.9 2.7 2.6 3.8 2.2 2.5

Finland 1.6 2.7 2.7 4.9 2.6 2.7

France 1.4 1.6 1.2 5.1 2.2 2.0

Germany 2.0 2.8 0.3 5.7 1.8 2.3

Italy 1.2 1.9 1.5 5.6 2.3 2.2

Netherlands 1.7 2.2 2.4 4.7 2.5 2.5

Norway 1.7 2.1 2.9 4.1 3.3 2.6

Sweden 1.6 2.2 2.7 3.7 1.8 2.3

Switzerland 1.9 2.6 2.6 4.5 1.2 n.a.

United Kingdom 2.1 1.9 1.2 2.9 2.1 2.0

Japan 0.4 2.4 2.2 9.3 2.7 2.7

United States 4.2 3.9 2.8 3.9 2.9 3.6

Table 3.01(b)

Sources: See p. 47 of text.

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Stylized fact #2

Growth rates differ substantially

between countries.

GDP per capita*, 1500-2001

Table 3.01(a)

Sources: See p. 47 of text.

1500 1820 1950 2001

Western Europe 771 1,204 4,579 19,256

China 600 600 439 3,583

*In 1990 international Geary-Khamis dollars

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Stylized fact #3

Even small differences in annual growth

rates accumulate to big differences in

income in the long run.

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0,0

2000,0

4000,0

6000,0

8000,0

10000,0

12000,0

14000,0

1947 1957 1967 1977 1987 1997 2007

Real GDP (avg. growth rate approx. 3.5%)

Theoretical GDP (avg. growth rate 1.75%)

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Stylized fact #4

In the long run cyclical fluctuations

matter much less than the average

growth rate.

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Actual and trend GDP, UK, 1963-2002

Fig. 14.01 (a)

300

400

500

600

700

800

900

Q1/1963 Q1/1969 Q1/1975 Q1/1981 Q1/1987 Q1/1993 Q1/1999

Bill

ions o

f 199

5 P

ound

s GDP in 1995 prices Trend

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2. The Solow growth model

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Some analytics

For the growth model we need a

production function

Example: Cobb-Douglas function

and transform to intensive form

or

L

K

L

Y

1LKY

ky

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Production function: intensive form

Output-labour

ratio

(y=Y/L)

0 Capital-labour ratio

(k=K/L)

Fig. 3.03

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Some analytics (2)

Changes in capital come from savings and

depreciation

assuming constant labour we can write in

intensive form

KYsK

kkskysk

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Review: The steady state

Output-labour

ratio

(y=Y/L)

0

y=f kProduction function

( )

=s f ksaving ( )

= kdepreciationB

A

D

C

k1

0k

0k

k2 kCapital-labour ratio

(k=K/L)

Fig. 3.04

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Growth in the Solow model (1)

If we are a poor economy (low capital

equipment k) like Poland, we can

expect to grow until the steady state is

reached

But how can we grow later?

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Growth in the Solow model - saving

rate increases

0

=s f kold saving ( )

= kdepreciation

Output-labour

ratio

(y=Y/L)

=s f knew saving ( )

Capital-labour ratio

(k=K/L)

Fig. 3.06

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Optimal savings rate

We cannot increase saving rates

forever – no source of permanent

growth

But is there an optimal savings rate?

The rate that gives maximum

consumption in the steady state

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Seeking largest sustainable

consumption

0

= kdepreciation

Output-labour

ratio

(y=Y/L) ( )y=f k


(k=K/L)

Fig. 3.07

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( )s f k

Golden rule saving rate

0

= kdepreciation

Output-labour

ratio

(y=Y/L) ( )y=f k

y

kCapital-labour ratio

(k=K/L)

Fig. 3.07

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Growth in the Solow model -

productivity increases

0

= kdepreciation

Output-labour

ratio

(y=Y/L)


(k=K/L)

Fig. 3.06

old technology f1(k)

new technology f2(k)

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Why does productivity increase?

Productivity growth can provide

permanent output growth

But the Solow model does not explain

productivity growth (it is exogenous)

Models of endogenous growth explain

more (Barro, Sala-i-Martin 1994)

3. Models of endogenous growth

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Endogenous growth

In the Solow model long-term growth

can be introduced only exogenously

This is neither very realistic nor a

satisfactory explanation

Several alternatives have been

presented in the literature, e.g.:

– The AK model

– Models of innovation M.Brzoza-Brzezina:


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The AK model (1)

Assume following production function:

Together with the capital accumulation

rule:

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tt AKY

ttt KYsK

The AK model (2)

Substituting yields the growth rate of

capital (and output):

Hence the AK economy grows

indefinitely.

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Ast

t

K

K

For and against the AK model

Nice to have a simple source of

permanent, endogenous growth

But AK model implies no convergence

(even not conditional)

And empirical estimates of elasticity of

output wrt capital usually fall much

below one (even if human capital is

accounted for)

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Models of innovation

Alternative source of endogenous growth can

be R&D

Models of innovation (e.g. Romer 1990;

Aghion & Howit 1992)

Assume that part of productive activity is

directed towards inventing new technologies

This allows to generate permanent growth

under more plausible assumptions than in the

AK model M.Brzoza-Brzezina:


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4. Sources of economic growth

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Factor:

Effect on

average annual

growth rate

Initial GDP -2.5

Education 1.2

Life expectancy 4.2

Fertility rate -1.6

Government consumption -1.4

Rule of law 2.9

Source: Barro (1997)

Summary effects on growth

Table 18.02

Sources: Barro (1991); Summers and Heston (1991)

Convergence hypothesis in reality

102 Countries (1960-97)

-4

-2

0

2

4

6

8

10

0 10 20 30

GNP per Capita in 1960 (1995 USD '000)

Avg

. g

row

th r

ate

pe

r ca

pita

(%

) 23 OECD Countries (1960-97)

1

2

3

4

5

6

0 10 20 30

GNP per Capita in 1960 (1995 USD '000)

Avg. gro

wth

rate

per

capita (

%)

Fig. 18.01

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The convergence hypothesis

Consistent with the Solow model

But empirically valid only in

homogenous subsamples

This is called conditional (or club)

convergence

Good news for Poland, bad news for

Zimbabwe

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0

10

20

30

40

50

60

70

80

90

100

Developed

countries

Less

developed

countries

China India Rest of

Asia

Latin

America

Northern

Africa

Sub-

Saharan

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

Adult literacy in 1950 (% of population, left scale) Average annual growth 1950-95 (%, right scale)

Human capital and growth (1950-95)

Africa

Fig. 18.04

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Human capital and growth

Relationship not so evident from the graph

But:

- very difficult to measure human capital

- growth depends on several factors (e.g. on initial income – works in opposite direction). Regression better than simple graph.

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Economic environment and growth

Various economic systems provide

various incentives to work and innovate

Again: difficult to measure

Separate branch of economics:

comparison of economic systems

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-2%

-1%

0%

1%

2%

3%

4%

5%

Bu

lga

ria

Cze

ch

oslo

va

kia

Hu

nga

ry

Po

lan

d

Ro

ma

nia

US

SR

Yu

go

sla

via

Ch

ina

Weste

rn

Eu

rop

e

1950-73 1973-92

Economic growth under socialism vs. W. Europe

Fig. 18.05

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Real GDP per capita in Sub-Saharan Africa

Source: Ndulu and O’Connell (1999)

Fig. 18.06

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Rule of law and growth

Rule of law:

- contract enforcement

- stability of law

- quality of bureaucracy

- corruption

- etc.

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Source: Easterly (1999)

Rule of law and growth

Fig. 18.07

Causality!

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Health and growth

Long life expectancy increases

incentives to invest in human capital

Better health means more productive

workers

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Per capita GDP and life expectancy

Source: Bloom, Canning, Graham and Svilla, (2000)

Fig. 18.08

Causality again!

Exercises & more

Calculate the golden rule savings rate in

the Solow model

Want to know more?

– Read Aghion & Howit „The Economics of

Growth”

– Take course in „Growth theory” at SGH

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Documents

1. What is Macroeconomics?mbrzez/Makro_II/Economic growth.pdf · Average annual real GDP growth rates Overall growth 1820-70 1870-1913 1913-50 1950-73 1973-2001 1820-2001 Belgium