11

Frank & BernankeFrank & Bernanke4th edition, 20094th edition, 2009

Ch. 7: Economic Growth Ch. 7: Economic Growth

22

Source: http://www.economist.com/displayStory.cfm?story_id=346598

33http://www.youtube.com/watch?v=jbkSRLYSojo

44

55

Can the gross domestic product per capita be used to measure human development instead of the HDI?

No. GDP per capita only reflects average national income. It tells nothing of how that income is distributed or how that income is spent - whether on

universal health, education or military expenditure. Comparing rankings on GDP per capita and the HDI can reveal much about the results of national

policy choices. For example, a country with a very high GDP per capita such as Oman, which has a relatively low level of educational attainment, can have a

lower HDI rank than, say, Uruguay, who has roughly 60% of the GDP per capita of Oman.

66

http://hdr.undp.org/en/statistics/data/

Human development in animationHuman development in animation

77

Real GDP per Person In Selected Real GDP per Person In Selected Countries, 1870-2000 (in 1995 U.S. Countries, 1870-2000 (in 1995 U.S.

Dollars)Dollars)

Country

Australia 5,626 7,385 9,561 18,033 24,708 1.1 1.9

Canada 2,447 5,791 9,362 20,899 26,604 1.8 2.1

France 2,249 4,401 6,049 17,801 22,447 1.8 2.6

Germany 1,205 2,320 5,005 18,014 23,247 2.3 3.1

Italy 2,248 3,167 4,042 13,331 21,930 1.8 3.4

Japan 963 1,825 2,216 16,899 24,772 2.5 4.8

United Kingdom 3,500 5,374 7,832 14,889 21,142 1.4 2.0

United States 2,843 6,745 11,921 22,480 32,629 1.9 2.0

Annual % change

1950-2000

Annual % change 1870-

20001870 1913 1950 1979 2000

Observations1870: Australia had the highest per capital real GDP and Japan the lowest2000 real per capita GDP in Japan exceeded AustraliaNote the difference in the growth rate of 1.1% for Australia and 2.5% for Japan

88

Real GDP per Person in Five Real GDP per Person in Five Industrialized Countries, 1870 - 2000Industrialized Countries, 1870 - 2000

99

Compound InterestCompound InterestSuppose you put $100 in a savings Suppose you put $100 in a savings

account for your retirement. How much account for your retirement. How much would you have in 50 years?would you have in 50 years?

You need to know the interest rate.You need to know the interest rate.At 1%, the savings at the end of one year At 1%, the savings at the end of one year

will be: 100 + 100*.01 = 100 (1+.01) = 101.will be: 100 + 100*.01 = 100 (1+.01) = 101.At the end of two years, the savings will At the end of two years, the savings will

be: 100(1.01) + 100(1.01)(.01) = 100(1.01)be: 100(1.01) + 100(1.01)(.01) = 100(1.01)(1.01) = 100 (1.01)(1.01) = 100 (1.01)22

1010

Compound InterestCompound Interest

1% 2% 4% 8% 10%Beginning Balance 100.00 100.00 100.00 100.00 100.00After one year 101.00 102.00 104.00 108.00 110.00After ten years 110.46 121.90 148.02 215.89 259.37After 30 years 134.78 181.14 324.34 1,006.27 1,744.94After 50 years 164.46 269.16 710.67 4,690.16 11,739.09

ObservationsA small sum compounded over long periods can greatly increase in valueSmall differences in interest have a very large impact on value

1111

Impact on Living StandardsImpact on Living Standards

GDP per capita grew at a rate of 2% per GDP per capita grew at a rate of 2% per year for US during the last 50 years.year for US during the last 50 years.

Japanese GDP per capita grew at a rate of Japanese GDP per capita grew at a rate of 5% during the same period.5% during the same period.

Chinese GDP per capita grew about 8% Chinese GDP per capita grew about 8% per year the last twenty years.per year the last twenty years.

1212

Real GDP per CapitaReal GDP per CapitaReal GDP per capita is found by dividing Real GDP per capita is found by dividing

the Real GDP by the population: Y/POP.the Real GDP by the population: Y/POP.We can rewrite Y/POP as Y/N times We can rewrite Y/POP as Y/N times

N/POP, since the Ns would cancel out N/POP, since the Ns would cancel out when the two terms are multiplied.when the two terms are multiplied.

Y/N is average labor productivity.Y/N is average labor productivity.N/POP is employed portion of the N/POP is employed portion of the

population.population.

1313

Growth Rate of Y/POPGrowth Rate of Y/POPPercentage growth of Y/POP will be Percentage growth of Y/POP will be

equal to percentage growth of Y/N equal to percentage growth of Y/N (Average Labor Productivity) PLUS (Average Labor Productivity) PLUS N/POP (Share of population employed).N/POP (Share of population employed).

We can get these numbers for US from We can get these numbers for US from government web sites: Bureau of Labor government web sites: Bureau of Labor Statistics, Bureau of Economic Statistics, Bureau of Economic Analysis, Federal Reserve Bank of St. Analysis, Federal Reserve Bank of St. Louis.Louis.

1414

0

10000

20000

30000

40000

50000

60000

70000

1945 1955 1965 1975 1985 1995 2005

GDP/cap AvLabProd

N/POP

0.000

0.100

0.200

0.300

0.400

0.500

0.600

1945 1955 1965 1975 1985 1995 2005

1515

US Experience and ForecastUS Experience and Forecast

Why did N/POP increase during the last Why did N/POP increase during the last 30 years?30 years?

What is expected for the future of N/POP?What is expected for the future of N/POP?How can US expect to raise average living How can US expect to raise average living

standards in the future?standards in the future?

1616

1717

http://www.economist.com/markets/indicators/displaystory.cfm?story_id=8632028

1818

Determinants of Average Labor Determinants of Average Labor ProductivityProductivity

Human CapitalHuman CapitalPhysical CapitalPhysical CapitalNatural ResourcesNatural ResourcesTechnologyTechnologyEntrepreneurship and ManagementEntrepreneurship and ManagementPolitical and Legal EnvironmentPolitical and Legal Environment

1919

Human CapitalHuman Capital

Human capital of workers includes theHuman capital of workers includes theTalentsTalentsEducationEducationTrainingTrainingSkillsSkills

http://www.npr.org/player/v2/mediaPlayer.html?action=1&t=1&islist=false&id=172034480&m=172038811

2020

Physical CapitalPhysical CapitalQuantity and quality of machines, tools, Quantity and quality of machines, tools,

equipment and buildings affect the equipment and buildings affect the productivity of labor.productivity of labor.How productive is a computer programmer How productive is a computer programmer

without a computer?without a computer?Using MB vs. MC principle to allocate Using MB vs. MC principle to allocate

machinery.machinery.Diminishing returns reduces the MB for the Diminishing returns reduces the MB for the

next machine.next machine.

2121

Natural ResourcesNatural Resources

Abundant land, energy, raw materials Abundant land, energy, raw materials will allow inputs to be cheap for will allow inputs to be cheap for producing certain products, giving a producing certain products, giving a country comparative advantage in these country comparative advantage in these products.products.

Free trade practically frees a country Free trade practically frees a country from the yoke of lack of natural from the yoke of lack of natural resources.resources.

2222

TechnologyTechnology

New technologies that increase the New technologies that increase the productivity of labor is commonplace in productivity of labor is commonplace in our age.our age.

New ways of organizing, presenting, New ways of organizing, presenting, sequencing, etc. are also considered sequencing, etc. are also considered technological advances.technological advances.

Technological improvements in one area Technological improvements in one area may have positive spillover effects in may have positive spillover effects in another industry.another industry.

2323

Entrepreneurship and ManagementEntrepreneurship and Management

Entrepreneurs take risks to introduce new Entrepreneurs take risks to introduce new products, new processes into the products, new processes into the economy.economy.

Societies that provide secure property Societies that provide secure property rights, low and predictable taxation and rights, low and predictable taxation and independent, incorruptible legal system independent, incorruptible legal system support the flourishing of entrepreneurial support the flourishing of entrepreneurial activity. (See M. Olson, activity. (See M. Olson, Power and Power and Prosperity.Prosperity.))

2424

Entrepreneurship and Entrepreneurship and ManagementManagement

China in the Middle Ages was far superior China in the Middle Ages was far superior to the West technologically. However, the to the West technologically. However, the social system stifled economic growth: social system stifled economic growth: application of technology to production.application of technology to production.

Management is every day operation of the Management is every day operation of the establishment. Education is supposed to establishment. Education is supposed to reduce the incidences of wrong decisions reduce the incidences of wrong decisions in everyday operations.in everyday operations.

2525

Political and Legal EnvironmentPolitical and Legal Environment

It is the function of the government to It is the function of the government to provide an environment where provide an environment where individuals and firms are not subjected to individuals and firms are not subjected to arbitrary rules, increasing the uncertainty arbitrary rules, increasing the uncertainty of efforts.of efforts.

Enforceable contracts, well-defined Enforceable contracts, well-defined property rights, political and social property rights, political and social environment conducive to taking risks in environment conducive to taking risks in production are responsibilities of production are responsibilities of governments.governments.

2626

The Determinants of Average The Determinants of Average Labor ProductivityLabor Productivity

Economic NaturalistEconomic NaturalistWhy did communism fail?Why did communism fail?

There was an absence of:There was an absence of: Private property rights.Private property rights. Free markets.Free markets. Political stability.Political stability. Modern legal framework.Modern legal framework.

2727

Worldwide Productivity Worldwide Productivity SlowdownSlowdown

Starting with 1973, industrialized nation Starting with 1973, industrialized nation experienced a significant productivity experienced a significant productivity slowdown.slowdown.

Slow growth brings social problems.Slow growth brings social problems.Redistribution can exacerbate these Redistribution can exacerbate these

problems.problems.

2828

Average Labor Productivity Growth Average Labor Productivity Growth Rates in Selected Countries, 1960-2000Rates in Selected Countries, 1960-2000

Country

France 4.6 2.3 1.8

Germany 4.0 2.6 2.0

Japan 7.6 2.7 2.0

United Kingdom 2.8 1.3 1.7

United States 2.3 0.6 1.7

1960-1973 1973-1979 1979-2000

Percentage growth, annual rates

2929

Why Did Productivity Slow Down?Why Did Productivity Slow Down?

Decline in public education?Decline in public education?Oil price shocks?Oil price shocks?Poor measurement of productivity gains in Poor measurement of productivity gains in

service sector?service sector?The exceptional experience of the 50s and The exceptional experience of the 50s and

60s?60s?

3030

Costs of Economic GrowthCosts of Economic Growth

Resources allocated to capital formation Resources allocated to capital formation will reduce production of consumer goods.will reduce production of consumer goods.

Unsanitary, unsafe conditions for industrial Unsanitary, unsafe conditions for industrial workers (historical for US, current for workers (historical for US, current for many LDCs).many LDCs).

Is the sacrifice today, worth better living Is the sacrifice today, worth better living conditions tomorrow?conditions tomorrow?

3131

How to Increase Growth Rates?How to Increase Growth Rates?

The factors that determine average labor The factors that determine average labor productivity may be enhanced by public productivity may be enhanced by public policy.policy.

3232

Policies to Increase Human Policies to Increase Human CapitalCapital

Education increases human capital. Education increases human capital. Why does the government provide “free” Why does the government provide “free”

K-12 education?K-12 education?Positive externalities: Private demand does Positive externalities: Private demand does

not capture all the societal benefits.not capture all the societal benefits.Who should decide the content of Who should decide the content of

curriculum?curriculum?

3333

Policies to Promote Saving and Policies to Promote Saving and InvestmentInvestment

Capital stock in a country increases Capital stock in a country increases through investment activities.through investment activities.

Investments require resources diverted Investments require resources diverted from consumption goods to capital goods.from consumption goods to capital goods.

If consumers do not restrict their If consumers do not restrict their consumption (if they don’t save) total consumption (if they don’t save) total expenditures will exceed the value of expenditures will exceed the value of production and inflation will ensue.production and inflation will ensue.

3434

Policies to Promote Saving and Policies to Promote Saving and InvestmentInvestment

High rates of saving allow a country to High rates of saving allow a country to channel resources into capital formation.channel resources into capital formation.

Governments can pass laws to promote Governments can pass laws to promote saving and laws to promote investment.saving and laws to promote investment.

Governments also can create capital stock Governments also can create capital stock directly (how does it pay?)directly (how does it pay?)

3535

Policies to Support R&DPolicies to Support R&D

Public good aspect of knowledge reduces Public good aspect of knowledge reduces private investment in knowledge.private investment in knowledge.

Collective decision-making is required for Collective decision-making is required for activities with higher social benefits than activities with higher social benefits than individual benefits, e.g. basic research. individual benefits, e.g. basic research.

3636

Legal and Political FrameworkLegal and Political Framework

Political stabilityPolitical stabilityFree and open exchange of ideasFree and open exchange of ideasSecure property rightsSecure property rightsWell functioning legal systemWell functioning legal systemFree markets (except for those with Free markets (except for those with

significant externalities)significant externalities)

3737

Promoting Economic GrowthPromoting Economic Growth

The Poorest Countries: A Special Case?The Poorest Countries: A Special Case? Improve the legal and political frameworkImprove the legal and political framework

Corrupt legal systems create uncertainty about Corrupt legal systems create uncertainty about property rightsproperty rights

Taxation and regulation discourages Taxation and regulation discourages entrepreneurshipentrepreneurship

Markets are not allowed to functionMarkets are not allowed to functionLack of political stability discourages foreign Lack of political stability discourages foreign

investmentinvestment

3838The Economist, Dec 23, 2006

3939

Promoting Economic GrowthPromoting Economic Growth

The Poorest Countries: A Special Case?The Poorest Countries: A Special Case?Without political stability, foreign aid will not Without political stability, foreign aid will not

be effective.be effective.

4040

Limits to Growth?Limits to Growth?

Will we run out of oil (natural resources)?Will we run out of oil (natural resources)?Market mechanisms: price incentivesMarket mechanisms: price incentives

Will we spoil the environment completely?Will we spoil the environment completely?Change in tastes and preferencesChange in tastes and preferences

Can we solve the global warming Can we solve the global warming problem? problem? Limits to collective decision-making.Limits to collective decision-making.

4141

Are There Limits to Growth?Are There Limits to Growth?

Limits to growth, assumes economic Limits to growth, assumes economic growth will take the form of what we have growth will take the form of what we have now.now.

4242

Are There Limits to Growth?Are There Limits to Growth?

Limits to growth, overlooks that growth Limits to growth, overlooks that growth expands society’s capacity to safeguard expands society’s capacity to safeguard the environment.the environment.

Limits to growth, underestimates the Limits to growth, underestimates the power of markets to deal with scarcity.power of markets to deal with scarcity.

4343

The Relationship between Air The Relationship between Air Pollution and Real GDP per PersonPollution and Real GDP per Person

Real GDP per person

Air

po

lluti

on

A

4444

Commodity PricesCommodity Prices

FIRST published in 1864, with figures stretching back to 1845, The Economist's commodity-price index is probably the world's oldest regularly published price index. Since October 2001, our dollar-based industrials index has risen by 76%, fuelled by Chinese demand for raw materials and, in part, the weakness of the dollar. Yet in real terms, industrial commodity prices are a mere 30% of their value in 1845

http://www.economist.com/printedition/displayStory.cfm?Story_ID=3651836

4545