chapter 7 economic growth: theory and policy once one starts to think about... [differences in...
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Chapter 7
Economic Growth:
Theory and Policy
Once one starts to think about . . . [differences in growth rates among countries], it is hard to
think about anything else.ROBERT E. LUCAS, JR.
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Three Pillars of Productivity Growth
• Growth policy– High sustainable long-run growth
• Potential GDP • Represented by production function
Y=zF(K,L)
• Stabilization policy– Keep actual GDP
• Close to potential GDP - short run• No high unemployment• No high inflation
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Three Pillars of Productivity Growth• Labor productivity grows:
– Larger capital stock (K↑)• Given technology & labor force
– Better technology (z↑)• Given capital & labor
– Workforce quality (L↑)• More education & training• Given capital, technology, labor force
• Human capitalHuman capital (education & training)– Amount of skill embodied in workforce
– Labor (L) = number of worker (N) * H 3
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Production functions corresponding to three different capital stocks
Figure 1
4
0
Hours of Labor Input
Out
put
L1
Ya
K1
Yb
Yc
K2
K3c
b
a
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Levels, Growth Rates, & Convergence
• Level of productivity– Higher in rich countries
– Depends on• Supply of human & physical capital• State of technology
• Growth rate of productivity– Depends on growth rates of
• Capital (K)• Workforce skills (H)• Technology (z)
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Productivity levels and productivity growth rates in selected countries
Table 1
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CountryGDP per hour of work 1980
(as percentage of U.S.)GDP per hour of work 2005
(as percentage of U.S.)Growth
rate
United StatesFranceUnited KingdomSpainIrelandArgentinaMexicoBrazilSouth Korea
1008671625751443320
1009985629637252348
1.72.32.41.73.90.4-0.50.25.4
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Levels, Growth Rates, & Convergence
• ConvergenceConvergence hypothesis– Nations with low levels of productivity
• High productivity growth rates
– International productivity differences• Shrink over time
– Poorer countries• Higher productivity growth
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The Convergence Hypothesis
Figure 2
8
0Time
Rea
l GD
P p
er c
apita
$2,000
Poorer country
$10,000
Richer country
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Levels, Growth Rates, & Convergence
• Technological laggards– Can close the income gap– Imitation, not innovation
• Adopt existing technologies– Example: Boeing 767 in domestic airline, cell phone
and internet access in China
– “Convergence club” • Productivity growth rates - higher
– Where productivity levels are lower (South Korea, China, India, Ireland, …)
• Poorest nations– Unable to join 9
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Levels and growth rates of GDP per capita in selected poor countries
Table 2
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Country GDP per capita 2005*
GDP per capita growth rate, 1990-2005
BelarusRussiaUkrainePeruHaitiBurundiSierra Leone
$1,8682,445960
2,337434105218
2.0%-0.4-2.42.3-2.4-2.5-0.9
*in constant 2000 U.S. dollars
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Growth Policy: Capital Formation
• Nation’s capital– Available supply
• Plant, equipment, software
– Result of past decisions – investments
• Investment– Flow of resources
• Production of new capital
– Inputs• Construction of capital
– Period of time 11
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Growth Policy: Capital Formation
• Capital formation– Investment
– Process of building up capital stock
• Trade-off– More capital formation
• Quicker growth • Consume less today
– More consumption today• Less capital formation• Slower growth 12
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Choosing between investment and consumption
Figure 3
13
0Consumer Goods Produced
Inve
stm
ent
Goo
ds P
rodu
ced
D
C
I
A
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Growth Policy: Capital Formation
• Speed up capital formation / investment– Lower real interest rates
– Tax provisions
– Technical change
– Growth of demand
– Political stability
– Property rights• Laws and/or conventions• Owners - rights to use their property
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Selected countries ranked by level of investor protection
Table 3
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Country Rating (0-10 scale)
SingaporeUnited StatesCanadaUnited KingdomJapanMexicoIndiaSwedenBrazilItalyChinaSwaziland
9.38.38.38.07.06.06.05.75.35.05.02.3
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Growth Policy: Education & Training
• More-educated & better-trained workers– Higher productivity– Higher wages
• Education policy– Improve quality of education
• Earning gap• High school graduates• College graduates
• On-the-job-training– Skills acquired at work 16
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Wage premium for college graduates over high school graduates
Figure 4
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Growth Policy: Technological Change
• Advancement of technology– More education
• Scientific, engineering, managerial
– More capital formation– Research & development (R&D)
• Inventing new products/processes• Improving existing ones
• R&D – encouraged by government– Tax credit– Collaborative research– Spending on R&D 18
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Productivity Slowdown & Speed-up, U.S.
• 1948-1973: 2.8%• 1973-1995 Productivity slowdown, 1.4%
– Lagging investment
– High energy prices
– Inadequate workforce skills
– Not: technological slowdown
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Average productivity growth rates in the United States, 1948–2007
Figure 5
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Productivity Slowdown & Speed-up, U.S.
• 1995-2007 Productivity speed-up, 2.5%– IT revolution
– Surging investment
– Falling energy prices
– Advances in information technology
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Growth in the Developing Countries
• Poorly endowed with capital– Difficult to accumulate capital
• Development assistance – foreign aid– Outright grants & Low-interest loans
– From rich countries & multinational institutions
– To spur economic development
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Growth in the Developing Countries
• Foreign direct investment– Purchase/construction
• Real business assets
– Multinational corporations
• Low level of technology• Low levels of education & training• Poor geographical conditions• Poor health• Governance
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Average educational attainment in selected countries, 2000
Table 4
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United StatesCanadaSouth KoreaJapanUnited KingdomItalyMexicoIndiaBrazilSudan
12.311.410.59.79.47.06.74.84.61.9
For people older than 25 years of age
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From the Long Run to the Short Run
• Over long periods of time– Similar growth rates
• Actual GDP• Potential GDP
• Macroeconomic fluctuations– GDP shrinks – recessions
• Needed: a short-run theory of AD (next chapter)
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Summary
• Source of economic growth (K, z, and H)
• Convergence hypothesis• Growth policy
– Capital formation– Improve education and training– Spur technical change
• Productivity slowdown and speed-up• Growth in the developing countries