Economic Growth PDF

3. Economic Growth 1. Facts of Economic Growth (1) There are vast differences in GDP per capita ECON 102 Page 1  Country Name GDP per capita, PPP (constant international $) Norway $67,460 United States...

3. Economic Growth 1. Facts of Economic Growth (1) There are vast differences in GDP per capita ECON 102 Page 1  Country Name GDP per capita, PPP (constant international $) Norway $67,460 United States $64,623Data from World Germany $53,970Bank for 2022 Canada $48,975 OECD members $46,208 Korea, Rep. $45,560 Japan $41,641 Mexico $20,255 China $18,188 World $17,523 Brazil $15,093 South Africa $13,479 Middle income $12,265 Philippines $8,582 India $7,112 Cameroon $3,724 Haiti $2,799 Ethiopia $2,381 Low income $1,949 Somalia $1,449 Congo, Dem. Rep. $1,133 (2) There are also vast differences in Growth Rates ECON 102 Page 2 If poorer countries grow faster, they should catch up with rich countries… …but it might take a long time. (3) Some countries do catch up… "Asian Tigers" ECON 102 Page 3 (4) …others don't ECON 102 Page 4  catching/caught up technological frontier losing ground (5) Economic Growth is a recent phenomenon ECON 102 Page 5  ► The industrial revolution kicked of economic growth in Western Europe + USA This all raises the following questions: (1) Where does economic growth come from? (2) Why and how do some poorer countries catch up? (3) Why do other poor countries not catch up? ECON 102 Page 6 2. The Sources of Economic Growth a) The Production Function 𝐿 − number of total hours of labour provided 𝐾 − amount of physical capital  machines  production facility  land  resources 𝐻 − amount of human capital  education 𝐴 − level of technology  research and development ECON 102 Page 7  How to increase output: □ Increase Labour Supply 𝐿  Does not necessarily increase the standard of living! 𝑌 𝐴𝐹 (𝐾, 𝐿, 𝐻) 𝐾 𝐻 ⎯⎯= ⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯= 𝐴𝐹 ⎯⎯, 1, ⎯⎯ 𝐿 𝐿 𝐿 𝐿 𝑌 ⎯⎯≡ 𝑦 = 𝐴𝑓(𝑘, ℎ) 𝐿 𝑦 − ouput per worker / productivity 𝑘 − capital per worker ℎ − human capital per worker 𝐴 − total factor productivity □ Increase capital per worker  capital accumulation □ Increase human capital per worker  education □ Increase level of technology  research and development we assume constant returns to scale ECON 102 Page 8  b) Malthusian Economic Growth production increases 𝑌 ↑  incomes increase 𝑌 ↑  infant mortality goes down  "An Essay on the Principle of Population" Thomas Malthus (1798) population increases 𝐿 ↑  standard of living is constant ⎯ = 𝑐𝑜𝑛𝑠𝑡. Notes: Economics was dubbed the "dismal science" Malthusian growth describes the pre-industrial revolution period well During the Industrial Revolution, productivity grew so rapidly that population growth could not keep up. Then, population growth started falling since 1950 https://ourworldindata.org/fertility-rate ECON 102 Page 9 c) Capital Accumulation ► Neoclassical Growth (Solow, 1956) (1) Diminishing Returns to Capital 𝑦 = 𝑓(𝑘) 𝑘 For a given amount of labour 𝐿, physical capital 𝐾 becomes less and less productive. (2) Capital Accumulation The capital stock per person increases with the amount of investment and decreases with the amount of depreciation ECON 102 Page 10  𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 = 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 − 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 investment > depreciation => capital stock increases investment < depreciation => capital stock decreases Assumptions: a constant share 𝛿 of the capital stock per person 𝑘 depreciates each period (year) investment/saving is a constant share of output/income 𝑠𝑦. ⇒ Δ𝑘 = 𝑠𝑦 − 𝛿𝑘 𝑦 𝑦 = 𝑓(𝑘) output 𝑦∗ 𝛿𝑘 depreciation 𝑠𝑦 investment 𝑘∗ 𝑘 capital accumulation ends at the steady state capital stock 𝑘 ∗ increases in output per capita through capital accumulation are limited capital accumulation predicts convergence in output per capita between poor countries (with low capital stock) and countries in their steady state (at the technological frontier). ECON 102 Page 11 Why are countries still growing once they reach the technological frontier? (3) Technological Progress 𝑦 = 𝐴𝑓(𝑘) ECON 102 Page 12  Technological progress leads to more production with the same amount of inputs Technological progress is the only way to achieve sustained economic growth (expansion of the technological frontier) Technology is usually 'labour-saving' d) Innovation ► New Growth Theory (1990s) Where does technological progress come from? □ Investment in research with positive externalities (1) ideas can be freely shared ► non-rivalry and non-excludability in consumption (2) ideas do not depreciate (3) ideas promote other ideas ► positive externality □ Creative Destruction  Least productive firms go bankrupt,  new firms enter the market  over time average productivity increases □ Technology Diffusion/Spillovers  international trade and direct investment let developing countries access newer technologies quicker (imitation) □ Education  education behaves similarly to capital stock and has decreasing returns ECON 102 Page 13  3. Government and Institutions Property Rights => ensure economic exchange Government Stability => encourages capital accumulation Subsidizing Education and Research => corrects positive externality ECON 102 Page 14  4. Sustainability a) Limited Economic Resources 𝑌 = 𝐴𝐹(𝐾, 𝐿, 𝑂 ) ► As the limited resource becomes more scarce, its price will increase ► As the limited resource becomes more expensive as an input factor, production processes shift away from it. ► Limited resources can slow down economic growth ECON 102 Page 15  b) Environmental Degradation Problem: Production processes that use fossil fuels have a negative production externality ► The negative impact on the environment is not priced in when making a production decision Overproduction compared to social optimum! Solution: Governments can correct the price through taxation  Carbon pricing Distributional Conflict: It is much easier for advanced countries to reduce emissions as they have already gone through the energy-intensive process of industrialization Kuznets Curve ECON 102 Page 16 5. Conclusion Countries need strong government institutions to grow Countries can grow fast through capital accumulation and investment in education until they reach the technological frontier At the technological frontier, countries grow at the rate of technological progress through innovation, research and development. High GDP growth needs to be traded off against other welfare-improving goals such as inequality or environmental degradation ECON 102 Page 17