Economic Growth 25 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Economic Growth

25

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Economic Growth

A look around the world today reveals huge differences in standards of living resulting from the disturbing fact that, although some countries have enjoyed decades or even centuries of steadily rising per capita income levels, other countries have experienced hardly any economic growth at all.

LO1 25-2

2 Ways to Measure Growth

• An increase in real GDP from one period to another.

• An increase in real GDP per capita, or per person, from one period to another.

With either definition, economic growth is calculated as a percentage rate per quarter or per year. Growth rates normally are positive, but not always.

Real GDP per capita = real GDP ÷ Population

Growth is a widely held economic goal. The expansion of total output relative to population results in rising real wages and incomes and thus higher standards of living. An economy that is experiencing economic growth is better able to meet people’s wants and resolve socio-economic problems. In short- growth lessens the burden of scarcity.

Economists pay a lot of attention to growth rates because over a long period of time, they can really add up. The mathematical approximation called the rule of 70 provides insight into the effects of economic growth. The rule tells us we can find the number of years it will take for some measure to double, given the annual percentage increase.

# years to double = 70 ÷ annual percentage growth rate

Table 25.1 gives an overview of economic growth in the U.S. since 1950. Real GDP has grown at about 3.2 % per year between 1950 and 2009. Real GDP per capita increased 2% per year over that time.

(1)Year

(2)Real GDP, Billions of

2005$

(3)Population,

Millions

(4)Real GDP,Per Capita,

2005$(2) ÷ (3)

1950 $ 2006 152 $12,197

1960 2831 181 15,640

1970 4270 205 20,829

1980 5839 228 25,610

1990 8034 250 32,136

2000 11,226 282 39,809

2009 12,987 307 42,303

Source: Bureau of Economic Analysis, http://www.bea.gov and U.S. Census Bureau, http://www.census.gov

Real GDP and Real GDP per Capita

LO1 25-7

Modern Economic Growth

Modern economic growth is characterized by sustained and ongoing increases in living standards that can cause dramatic increases in the standard of living within less than a single lifetime. Economic historians date the start of the industrial revolution at about 1776 with the development of the steam engine.

LO2 25-8


The new factories mass-produced goods for the first time. This meant that nearly all manufacturing shifted from items produced by hand to items mass-produced in distant factories. New steamships and steam locomotives transported resources to the factories which then made the products that were transported back to consumers at low cost.

LO2 25-9


The result was a huge increase in long distance trade and a major population shift from rural areas to towns and cities. Electric power would soon replace steam power and a multitude of inventions followed, including railroads, motorized vehicles, telephones, airplanes, container ships, computers and the internet. But the biggest change has been change itself.


Today, people living in many countries are constantly exposed to new technologies, new products, and new services. People have also been affected culturally, socially and politically. In addition, the average lifespan has increased from 30 years in the late 1700’s to an average of 67 today.

Uneven Distribution of Growth

Modern economic growth has spread only slowly from its British birthplace. It first advanced to France, Germany, and other parts of western Europe in the late 1800’s before spreading to the United States, Canada, and Australia by the mid 1800’s.


Japan began to industrialize in the 1870’s, but the rest of Asia did not follow until the early to mid 1900’s, at which time large portions of Central and South America as well as the Middle East also began to experience modern economic growth. Most recent has been Africa, which for the most part did not experience modern economic growth until the last few decades.


The huge divergence in living standards caused by the fact that different countries started growth at different times is best seen in Figure 25.1, which shows how GDP per capita has evolved since 1820. To make the comparisons easier, income levels in all places and at all times have been converted into 1990 U.S. dollars.


Countries that began modern economic growth more recently are not doomed to be permanently poorer than the countries that started earlier. This is true because people can adopt technology more quickly than they can invent it.


The richest countries today have achieved that status because they have the most advanced technology. But because they already have the most advanced technology, they must invent new technology to get even richer.


Because inventing and implementing new technology is slow and costly, real GDP per capita in the richest leader countries typically grows by an average annual rate of just 2 or 3% per year.


By contrast, poorer follower countries can grow much faster because they can simply adopt existing technologies from the rich leader countries. This can continue until they have caught up with the leader countries and become leader countries themselves. Once that happens, their growth rates fall down to the 2 to 3% rate typical of leader countries.


Table 25.2 shows both how the growth rates of leader countries are constrained by the rate of technological progress as well as how certain follower countries have been able to catch up by adopting more advanced technologies and growing rapidly. GDP’s and GDP’s per capita for all countries are expressed in terms of 2005 U.S. dollars.


You may be puzzled as to why the GDP per capita for the U.S. in 2007 is so much higher than the other leader countries like France and Britain. One important reason is that U.S. citizens put in substantially more labor time than do citizens of most other leader countries.


So why do Americans supply more labor than workers in France and other rich leader countries?

• Cultural differences regarding the proper balance between work and leisure.

• Stronger unions in France and other countries.• More generous unemployment and welfare

programs in France and other countries.• Higher tax rates in France and other countries.


Real GDP Real GDP Average annual per capita, per capita, growth rate,

Country 1960 2007 1960-2007

United States $ 14,766 $42,887 2.3%United Kingdom 11,257 32,181 2.3France 9,347 29,663 2.5Ireland 6,666 41,625 4.0Japan 5,473 30,585 3.7Singapore 4,149 44,619 5.2Hong Kong 3,849 43,121 5.3South Korea 1,765 23,850 5.7

Figures are in 2005 dollars

Source: Penn World Table version 6.3, pwt.econ.upenn.edu

LO2 25-22


LO3 25-23

Institutional Structures of Growth

• Strong property rights- people will not invest if they think others can steal or take away their ideas.

• Patents & Copyrights- By giving inventors and authors the exclusive right to market and sell their creations, patents and copyrights give strong financial incentive to invent and create.

• Efficient financial institutions- are needed to channel the savings of households toward businesses, entrepreneurs, and inventors.

LO3 25-24

Institutional Structures that Promote Growth

• Literacy and widespread education- is needed so that new technologies can be developed and also so it can be implemented and put to use.

• Free trade- promotes economic growth by allowing countries to specialize so that different types of output can be produced where they can be made most efficiently. It also promotes the spread of new ideas from one country to another.

• A comptetitive market system- uses prices and profits to serve as signals to firms about what to make and how much of it to make.

Determinants of Growth

1.Supply factors- 4 of the determinants relate to the physical ability of the economy to expand.

• Increases in the quantity and quality of natural resources.

• Increases in the quantity and quality of human resources.

• Increases in the supply/stock of capital goods.• Improvements in technology.

LO3 25-26


2.Demand Factor- to achieve the higher production potential created by the supply factors, households, businesses, and government must purchase the economy’s expanding output of goods and services.

LO3 25-27


3.Efficiency factor- to reach its full production potential, an economy must achieve economic efficiency as well as full employment. In other words, the economy must use its resources in the least costly way and to produce the output most valued by society.

Production Possibilities Analysis

Let’s look at figure 25.2. Remember that a PPF indicates the various possible combinations of products an economy can produce with its fixed resources and constant technology. An improvement in any of the supply factors will push the PPF outward as from AB to CD.

The demand factor reminds us that an increase in total spending is needed to move the economy from a point like (a) on curve AB to any of the points on the higher curve CD. Normally, increases in total spending match increases in production capacity, and the economy moves from a point on the previous curve to a point on the expanded curve.

Occasionally, the economy may end up at some point like (c) in figure 25.2 which represents a recession such as the one from 2007-2009.

a

EconomicGrowth

b

D

Production Possibilities

LO3

B

A

C

Consumer Goods

Ca

pit

al G

oo

ds

c

From Chapter 1:

25-32

Labor & Productivity

Although demand and efficiency factors are important, discussions of economic growth focus primarily on supply factors. Society can increase its real output and income in 2 fundamental ways.

• By increasing its inputs of resources.• By raising the productivity if those resources.

Labor & Productivity

Figure 25.3 indicates that a nation’s real GDP depends on the input of labor( measured in hours of work) multiplied by labor productivity( measured as real output per hour of work).

• Real GDP = hours of work × labor productivity

Labor and Productivity

• Size of employed labor force

• Average hours of work

LaborInputs(hours ofwork)

• Technological advance

• Quantity of capital

• Education and training

• Allocative efficiency

• Other

LaborProductivity(average output per hour)

RealGDP

Real GDP = hours of work x labor productivity

x =

LO3 25-35

Accounting for Growth

The president’s Council of Economic Advisors uses a system called growth accounting to assess the relative importance of the supply factors that contribute to changes in real GDP. Table 25.3 provides relevant data on the U.S. for 5 periods.

U.S. Economic Growth

Item

1953 Q2

To 1973 Q4

1973 Q4

To 1995 Q4

1995 Q4

To 2001 Q1

2001 Q1

To 2007 Q3

Projected

2009 Q1

To 2020 Q4

Increase in real GDP 3.6 2.8 3.8 2.6 2.5

Increase in quantity of labor 1.1 1.3 1.4 -0.1 0.2

Increase in labor productivity 2.5 1.5 2.4 2.7 2.3

Accounting for the Growth of U.S. Real GDP, 1953-2007, Plus Projection from

2009-2020

(Average Percentage Changes)

Source: Derived from Economic Report of the President, 2008, p. 45; and Economic Report of the President, 2010, p. 76

LO3 25-37

Accounting for Growth

It is clear from the table that both increases in the quantity of labor and increases in labor productivity are important sources of growth. Productivity growth has usually been the more important factor, with the exception of the 1973-1995 period when productivity growth slowed greatly. The following 5 factors appear to explain changes in productivity growth rates.

LO3 25-38

1.Technological advance- the largest contributor to productivity growth is technological advance, which is thought to account for about 40% of productivity growth. This includes not only innovative production techniques but new managerial methods and new forms of business organization that improve the process of production.

2.Quantity of capital- helps explain roughly 30% of productivity growth. More and better plant and equipment make workers more productive. Although some capital substitutes for labor, most capital is complementary to labor. In 2008 the quantity of capital available per worker was about $118,200 per worker. Public investment in U.S. infrastructure has grown and helped complement private capital development.

3.Education and Training- represents what’s called human capital- the knowledge and skills that make a worker productive. An estimated 15% of productivity growth derives from investments in people’s education and training. Figure 25.4 shows the level of educational attainment for the U.S. population. Global Perspective 25.1 shows test scores in both math and science for several countries.

Accounting for GrowthAverage Test Scores of Eighth GradeStudents in Math and Science, 2007

Mathematics Science

LO3 25-42

4.Economies of Scale- Reductions in per-unit production costs that result from increases In output levels are called economies of scale. Markets have increased in size over time, allowing firms to increase output levels and thereby achieve production advantages associated with greater size.

LO4 25-43

5.Improved resource allocation- means that workers over time have moved from low-productivity employment to high-productivity employment. An example would be moving from agriculture to manufacturing.

LO4 25-44

Productivity Growth

LO5 25-45

Is Growth Desirable?

1.The Antigrowth View- Critics of growth say industrialization and growth result in pollution, climate change, ozone depletion, and other environmental problems. The more rapid our growth and the higher our standard of living, the more waste the environment must absorb.

LO5 25-46

In an already wealthy nation, further growth usually means satisfying increasingly trivial wants at the cost of mounting threats to the ecological system. Critics also point out there is little compelling evidence that economic growth has solved sociological problems such as poverty, homelessness, and discrimination.

LO5 25-47

The changing technology at the core of growth poses new anxieties and new sources of insecurity for workers as they face the prospect of having their skills and experience rendered obsolete by onrushing technology. The increased stress that goes with technology may also impair our physical and mental health. Finally, critics also cast doubt on whether high rates of growth are sustainable.

2.In Defense of Economic Growth- The primary defense of growth is that it is the path to the greater material abundance and higher living standards desired by the vast majority of people.

Growth also enables society to improve the nation’s infrastructure, enhance the care of the sick and elderly, provide greater access for the disabled, and provide more public services in general. Growth has also provided an increase in our leisure time, giving us more time for reflection and self-fulfillment.

Those who support growth admit there are serious environmental problems, but say that limiting growth is the wrong solution. Growth has allowed economies to reduce pollution, be more sensitive to environmental considerations, set aside wilderness areas, create national parks, and clean up hazardous waste, while still enabling rising household incomes.

Last Word: Growth in China

1.Growth averages past 25 years:•9% annual growth output•8% annual growth output per capital2.Real GDP and real income have grown

more rapidly than China’s population.3. Per capita income was $3678 in 2009.4. Huge increase in international trade.

LO5 25-52

Growth in China

5. China has experienced some periods of high inflation,15 to 25%.

6. Financial system remains weak.7. Unemployment is also a problem, especially in the

interior of the country.8. Joined WTO in 2001 Agreed to cut tariffs Remove restrictions on foreign ownership Protect intellectual property rights

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Economic Growth 25 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved