Long-Run Economic Growth

[Audio] 9(24) Long-Run Economic Growth Cover Credits: Currency Exchange Stock Chart: cemagraphics/Getty Images, Social Media Montage: SEAN GLADWELL/Getty Images, Circuit Pattern: somsak Tangdamrongsub/Getty Images, Cargo Containers: urzine/Getty Images.

[Audio] WHAT YOU WILL LEARN IN THIS CHAPTER Why is long-run economic growth measured as the increase in real GDP per capita? How has real GDP per capita changed over time in different countries? Why is productivity the key to long-run economic growth? How is productivity driven by physical capital, human capital, and technological progress? Why do long-run growth rates differ so much among countries? How does growth vary among several important regions of the world? Why does the convergence hypothesis apply to economically advanced countries? How do scarcity of natural resources and environmental degradation pose a challenge to sustainable long-run economic growth?.

[Audio] GROWTH HAS BENEFITS AND COSTS Delhi and Beijing have terrible air quality—which is a bad thing. But it’s a by-product of a very good thing: the remarkable economic growth..

[Audio] COMPARING ECONOMIES ACROSS TIME AND SPACE (1/2) The key statistic is real GDP per capita—real GDP divided by population. We focus on GDP because GDP measures the income earned in the economy in a given year. We use real GDP because we want to separate changes in the quantity of goods and services from the effects of a rising price level. We focus on real GDP per capita because we want to isolate the effect of changes in the population..

[Audio] COMPARING ECONOMIES ACROSS TIME AND SPACE (2/2) Since 1980, India and China had a much higher growth rate than the United States. The standard of living achieved in the United States in 1900 was attained by China in 2008. As of 2018, India’s standard of living is still below that of the United States in 1900..

[Audio] LEARN BY DOING: PRACTICE QUESTION 1 Suppose the real GDP for Macronesia is $200 million in 2010. Furthermore, suppose population in Macronesia is 100,000 in 2010. If population increases to 105,000 in 2011 while GDP increases by 5%, then it must be true that real GDP per capita in Macronesia in 2011: increased. decreased. stayed constant. may have increased, decreased, or remained constant..

[Audio] LEARN BY DOING: PRACTICE QUESTION 1 (Answer) Suppose the real GDP for Macronesia is $200 million in 2010. Furthermore, suppose population in Macronesia is 100,000 in 2010. If population increases to 105,000 in 2011 while GDP increases by 5%, then it must be true that real GDP per capita in Macronesia in 2011: increased. decreased. stayed constant. (correct answer) may have increased, decreased, or remained constant..

[Audio] REAL GDP PER CAPITA The U.S. economy produces almost eight times as much per person as in 1900. Table 1 U.S. Real GDP per Capita Year Percentage of 1900 real GDP per capita Percentage of 2018 real GDP per capita 1900 100% 15% 1920 126 18 1940 149 22 1960 225 33 1980 368 54 2000 571 83 2018 688 100.

[Audio] INCOMES AROUND THE WORLD, 2021 The United States has grown quickly, while some nations have stalled. A quarter of the world’s population lives in countries where the standard of living is lower than it was in the United States in 1900..

[Audio] GROWTH RATES How did the United States manage to produce over eight times as much real GDP per person in 2018 than in 1900? It’s a gradual process when real GDP per capita grows a few percent per year. It’s helpful to use the Rule of 70 that tells us how long it takes for a variable to double: Example: If real GDP per capita is growing at an annual growth rate of 3.5%, it will double in 70/3.5 = 20 years. Small improvements in growth add up fast due to the power of compounding..

[Audio] LEARN BY DOING: PRACTICE QUESTION 2 Let's figure out how long it will take for the average Indian to be as wealthy as the average Western European is today. Note that all numbers are adjusted for inflation. India's GDP per capita is $3,000, and let’s assume real output per person grows at 5% per year. Using the rule of 70, how many years will it take for India to reach Italy's current level of GDP per capita, about $24,000 per year? 42 years 14 years 28 years 12 years.

[Audio] LEARN BY DOING: PRACTICE QUESTION 2 (Answer) Let's figure out how long it will take for the average Indian to be as wealthy as the average Western European is today. Note that all numbers are adjusted for inflation. India's GDP per capita is $3,000, and let’s assume real output per person grows at 5% per year. Using the rule of 70, how many years will it take for India to reach Italy's current level of GDP per capita, about $24,000 per year? 42 years (correct answer) 14 years 28 years 12 years.

[Audio] COMPARING RECENT GROWTH RATES. COMPARING RECENT GROWTH RATES.

[Audio] THE SOURCES OF LONG-RUN GROWTH Long-run economic growth depends on one ingredient: rising productivity. Sustained economic growth occurs only when the amount of output produced by the average worker increases steadily. Labor productivity (often called productivity): output per worker. Productivity is simply real GDP divided by the number of people working..

[Audio] EXPLAINING GROWTH IN PRODUCTIVITY Why does the average worker today produce far more a century ago? Modern workers have more physical capital, are better educated, and take advantage of a century’s technological progress. Three sources of productivity growth: Increase in physical capital Physical capital: human-made resources, such as buildings and machines. Increase in human capital Human capital: the improvement in labor created by the education and knowledge embodied in the workforce. Technological progress: an advance in technical means of production of goods and services..

[Audio] ACCOUNTING FOR GROWTH: THE AGGREGATE PRODUCTION FUNCTION (1/3) How much does output change when we change inputs? Aggregate production function: a hypothetical function that shows how productivity (real GDP per worker) depends on the quantities of physical capital per worker, human capital per worker, and technology. Example: GDP per worker = T × (Physical capital per worker)1/3 × (Human capital per worker)2/3 where T is an estimate of the level of technology, and human capital is years of education..

[Audio] ACCOUNTING FOR GROWTH: THE AGGREGATE PRODUCTION FUNCTION (2/3) Aggregate production function exhibits diminishing returns to physical capital: When the amount of human capital per worker and the state of technology are held fixed, each successive increase in the amount of physical capital per worker leads to a smaller increase in productivity. For example, a second computer improves one’s productivity, but not by as much as the first computer did..

[Audio] PHYSICAL CAPITAL AND PRODUCTIVITY. Physical capital per worker Real GDP per worker.

[Audio] ACCOUNTING FOR GROWTH: THE AGGREGATE PRODUCTION FUNCTION (3/3) Diminishing returns is an “other things equal” phenomenon: it holds true when the amount of human capital per worker and the technology are held fixed. Diminishing returns may disappear if we increase the amount of human capital per worker, or improve the technology, or both. In practice, all the factors contributing to higher productivity rise over time: both physical capital and human capital per worker increase, and technology advances as well..

[Audio] GROWTH ACCOUNTING (1/2) Growth accounting: estimates of the contribution of each major factor in the aggregate production function to economic growth. Total factor productivity: the amount of output that can be produced with a given amount of factor inputs. When total factor productivity increases, the economy can produce more output with the same quantity of physical capital, human capital, and labor..

[Audio] TECHNOLOGICAL PROGRESS AND PRODUCTIVITY GROWTH Technological progress raises productivity and shifts the aggregate production function upward..

[Audio] GROWTH ACCOUNTING (2/2) Increases in total factor productivity are central to economic growth. Technological progress drives increases in total factor productivity. According to the Bureau of Labor Statistics, over the period from 1948 to 2022, American labor productivity rose 2.1% per year. 49% of that rise is explained by increases in physical and human capital per worker; the rest is explained by rising total factor productivity—by technological progress..

[Audio] WHAT ABOUT NATURAL RESOURCES? Natural resources certainly influence productivity, but in the modern world, they are less important than human or physical capital. Japan, for example, has very few natural resources but very high real GDP per capita. Nigeria is a resource-rich nation but low real GDP per capita..

[Audio] WHY GROWTH RATES DIFFER (1/4) Rapidly growing economies excel at: Savings and investment spending Education Research and development.

[Audio] WHY GROWTH RATES DIFFER (2/4) Saving and Investment Spending In 2021, investment spending was 42% of China’s GDP, compared with only 21% in the United States. Money for investment spending comes from savings. Countries with that have high investment spending do so because they have high domestic savings..

[Audio] WHY GROWTH RATES DIFFER (3/4) Education China’s success at adding human capital is one key to its spectacular long-run growth..

[Audio] WHY GROWTH RATES DIFFER (4/4) Research and development (R&D): spending to create and implement new technologies. Scientific advances make new technologies possible. R&D translates scientific knowledge into useful products and processes. U.S. businesses were among the first to adopt R&D. In 1875, Thomas Edison created the first modern industrial research laboratory..

[Audio] THE ROLE OF GOVERNMENT IN PROMOTING ECONOMIC GROWTH (1/4) Government policies can increase the economy’s growth rate through the following six channels: Government subsidies to infrastructure Infrastructure: roads, power lines, ports, information networks, and other underpinnings for economic activity. China spends more on infrastructure than Western Europe and North America combined. Government subsidies to education Literacy in China has been increasing more rapidly than in Argentina. This isn’t because China is richer than Argentina; it’s because the Chinese government has made education a priority..

[Audio] THE ROLE OF GOVERNMENT IN PROMOTING ECONOMIC GROWTH (2/4) Government subsidies to R&D The internet grew out of the Advanced Research Projects Agency Network (ARPANET), created by the U.S. Department of Defense. Maintaining a well-functioning financial system If people distrust banks, they’ll keep gold or cash in safe deposit boxes or under the mattress, where it cannot be turned into productive investment spending..

[Audio] THE ROLE OF GOVERNMENT IN PROMOTING ECONOMIC GROWTH (3/4) Protection of property rights Property rights are the legal rights held by owners of valuable items to dispose of those items as they choose. Intellectual property rights are the rights of innovators to accrue the rewards of their innovations. Generally, governments protect intellectual property rights by giving patents (government-created temporary monopolies given to innovators for the use or sale of their innovations)..

[Audio] THE ROLE OF GOVERNMENT IN PROMOTING ECONOMIC GROWTH (4/4) Political stability and good governance There’s not much point in investing in a business if rioting mobs are likely to destroy it. Economic success of the United States has been possible because there are good laws, institutions that enforce those laws, and a stable political system that maintains those institutions..

[Audio] EAST ASIA’S MIRACLE (1/2) It took South Korea only 35 years to achieve growth that required centuries elsewhere. Since 1975, the East Asian region has increased real GDP per capita by 6% per year, more than three times America’s historical rate of growth. How have the Asian countries achieved such high growth rates? Very high savings rates allow businesses to borrow and add more physical capital per worker. Very good basic education has permitted a rapid improvement in human capital. Substantial technological progress..

[Audio] EAST ASIA’S MIRACLE (2/2) Economic growth can be especially fast in countries that are playing catch-up to countries with higher GDP per capita. East Asian economies grew fast because they adopted the technologies that already existed. The convergence hypothesis: differences in real GDP per capita among countries tend to narrow over time. But having a low real GDP per capita is no guarantee of rapid growth, as the examples of Latin America and Africa demonstrate..

[Audio] LATIN AMERICA’S DISAPPOINTMENT What’s holding Argentina (and other Latin American nations) back? Irresponsible government action that eroded savings through high inflation Lack of emphasis on education Political instability.

[Audio] AFRICA’S TROUBLES AND PROMISE What’s holding much of Africa back? Government corruption Civil wars and political instability Unfavorable geography Is Africa poor because it is politically unstable or unstable because it is poor? Good news: Nigeria’s per capita GDP, after decades of stagnation, turned upward after 2000, achieving an annual growth rate of 2.5% from 2000 to 2021..

[Audio] LEFT BEHIND BY GROWTH? Historically, rising real GDP per capita has translated into real income for most people. This is less and less true in the United States. A growing share of income went to a few people at the top. Two qualifications: economic growth still raises the standard of living of the great majority of the population and gives rise to a global middle class..

[Audio] LEARN BY DOING: PRACTICE QUESTION 3 Economic growth can be especially fast: for countries playing catch-up with countries that already have high real GDP per capita. for relatively poor countries if the convergence hypothesis holds true. if the country is able to benefit from adopting the technological advances already used in advanced countries. Answers (a), (b), and (c) are all true..

[Audio] LEARN BY DOING: PRACTICE QUESTION 3 (Answer) Economic growth can be especially fast: for countries playing catch-up with countries that already have high real GDP per capita. for relatively poor countries if the convergence hypothesis holds true. if the country is able to benefit from adopting the technological advances already used in advanced countries. Answers (a), (b), and (c) are all true. (correct answer).

[Audio] IS WORLD GROWTH SUSTAINABLE? Sustainable long-run economic growth: long-run growth that can continue in the face of the limited supply of natural resources and the impact of growth on the environment..

[Audio] NATURAL RESOURCES AND GROWTH, REVISITED “Neo-Malthusian” theories claim that economic growth will be severely limited by lack of resources. Economists believe that modern economies handle scarcity fairly well. Resource scarcity leads to high prices, and these high prices provide strong incentives to conserve the resource and find alternatives. After the sharp oil price increases of the 1970s, U.S. consumers turned to smaller, more fuel-efficient cars..

[Audio] ECONOMIC GROWTH AND THE ENVIRONMENT (1/2) Economic growth tends to have the adverse impact on the environment: pollution, loss of wildlife habitats, extinction of species, and reduced biodiversity. There’s local environmental degradation and global environmental degradation. It’s easier to reduce local environmental harm and it’s more difficult to address global environmental degradation, in particular, the problem of climate change..

[Audio] ECONOMIC GROWTH AND THE ENVIRONMENT (2/2) Climate change: changes in Earth’s climate brought about by human activity. Unmitigated climate change will cost 20% of world gross domestic product by 2100. Moreover, these costs tend to fall more heavily on poor countries. Climate change is been a hard problem to solve because it requires the cooperation of many countries. The United States enacted major climate legislation in 2022: Inflation Reduction Act. Relies on green energy subsidies to reduce greenhouse gas emissions. Many experts on climate policy are optimistic that the Act will greatly reduce emissions with little if any negative impact on economic growth..