LS08 - Economic Growth PDF

Kosmas Marinakis, Ph.D. Previously in E&S…  Definition of macroeconomics...

Kosmas Marinakis, Ph.D. Previously in E&S…  Definition of macroeconomics  Measuring GDP production, expenditure, income Lecture 8  Circular flows Economic Growth  Real vs. Nominal GDP CPI  Inequality among countries  Components of happiness not counted in GDP  Income per capita Economics  Productivity & Society © 2019 Kosmas Marinakis, SMU Lecture 8 2 1 2 Economic Growth GDP GROWTH Lecture 8 3 4 GDP Growth GDP Growth Economic growth GDP per capita PPP (2005 Int $) 100K Singapore  Economic growth refers to the increase in GDP per capita of an economy USA  The GDP growth rate is defined as the percentage change in GDP between Germany 80K UK two years, relative to the beginning period: Luxembourg 𝐺𝐷𝑃 − 𝐺𝐷𝑃 Ireland 𝐺𝑟𝑜𝑤𝑡ℎ = 60K Greece 𝐺𝐷𝑃 Malaysia  Over the last 200 years, GDP per capita around the world is increasing China 40K India though the increase is not entirely steady and there are some jagged movements corresponding to economic fluctuations 20K  Today we will focus on the long term trend of GDP instead of shorter, temporary fluctuations 0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016  © 2019 Kosmas Marinakis, SMU Lecture 8 5 © 2019 Kosmas Marinakis, SMU Lecture 8 6 5 6  GDP Growth GDP Growth GDP per capita (2000 US dollars) Exponential growth 60,000  GDP grows at an approximately constant growth rate Singapore USA new growth builds on past growth and its effects compound 50,000  Modest differences in growth rates translate into large GDP gaps after many 40,000 years  Starting from GDP = 100 with growth 2%; GDP after 20 years becomes 146 30,000  Starting from GDP = 100 with growth 3%; GDP after 20 years becomes 175 20,000  The exponential nature of economic growth is one of the major reasons for the large differences across countries 10,000 Growth 1% 3% 5% 10% 2x 71 years 25 years 15 years 8 years 0 3x 112 years 38 years 24 years 13 years 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015   © 2019 Kosmas Marinakis, SMU Lecture 8 7 © 2019 Kosmas Marinakis, SMU Lecture 8 8 7 8 GDP Growth GDP Growth Growth rate GDP pc PPP (2005 Int $) Annual implied GDP growth (2005 $) 20% GDP pc GDP pc Annual 1960 2010 Growth 15% United States 15,398 41,365 2.00% UK 11,204 34,268 2.26% France 10,212 31,299 2.27% 10% Spain 6,316 27,332 2.97% Singapore 4,383 55,862 5.22% 5% South Korea 1,656 26,609 5.71% Singapore Haiti 1,513 1,410 −0.14% China 772 7,746 4.72% 0% India 720 3,477 3.20% Greece 534 26,918 8.16% -5% D. R. Congo 696 241 −2.10% 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015   © 2019 Kosmas Marinakis, SMU Lecture 8 9 © 2019 Kosmas Marinakis, SMU Lecture 8 10 9 10 GDP Growth GDP Growth Average annual growth rate of GDP Catch-up growth Total  Catch up growth is the typically large growth rates exhibited by countries of Countries Includes Guatemala, Iran, below world-average GDP 35 Mexico Includes France,  Those countries benefit from technologies invented in the developed 30 Spain, Includes Ghana, UK, countries and grow fast 25 Kenya, USA Rwanda mostly due to availability of underutilized production factors Includes 20 Ireland, Japan  But also because of increasing their investment, efficiency of labor and Includes 15 Haiti, Includes efficiency of production Central African Botswana, Includes 10 Republic, China, Singapore, Nicaragua Malaysia, S. Korea  Not all economies were able to experience catch-up growth 5 Includes Thailand D.R. Congo several examples of stagnation and slow development 5% Income group  © 2019 Kosmas Marinakis, SMU Lecture 8 11 © 2019 Kosmas Marinakis, SMU Lecture 8 12 11 12  GDP Growth Sustained growth  Sustained growth is when a steady positive trend of growth persists for several decades  United States, the UK, France, Netherlands, Canada, Spain have demonstrated sustained growth for the last two centuries  Our goal is to understand how this type of sustained growth emerges and what factors determine the growth rate of an economy GROWTH HISTORY © 2019 Kosmas Marinakis, SMU Lecture 8 13 13 14 History of Growth History of Growth Growth before the 1800 Lack of sustained growth before the 1800s  Before the modern times, economies did not exhibit sustained growth  There are three reasons for the lack of  Ancient Greece, ancient Rome and Venice experienced prolonged periods of sustained growth before the modern times: growth 1. Technology: Before the 1800s, the pace of but this growth was slow and did not last technological change was much slower  During the heydays of these civilizations, standards of living improved and than today economic activity increased ominously 2. Inequality: Improvements in aggregate  Ancient Rome was growing slowly but steadily for over 300 years, but its growth incomes did not typically translate into increases in income per capita ultimately came to an end 3. Bad leadership: Entire nations were affected by the bad choices of their  Why those societies could not sustain growth endlessly? leaders not prioritizing lifting their nation out of poverty or even “forgetting” technological breakthroughs of the past  © 2019 Kosmas Marinakis, SMU Lecture 8 15 © 2019 Kosmas Marinakis, SMU Lecture 8 16 15 16 History of Growth History of Growth Malthusian limits to growth Breaking away from the Malthusian cycle  In 1798 Thomas Malthus published his theory about fertility  The Malthusian model was a good representation till the 1800s fertility: the number of children per woman still is for animal populations (e.g. locust swarms, rabbits, pigeons, rats)  According to Malthus, fertility would adjust so that income per  Before 1800, the vast majority of population was employed in food production capita would always remain close to the subsistence level  After 1800, technology enabled large parts of population to work in sectors  That is, when the GDP pc would be above the subsistence level, outside food production families would have more kids, lowering the GDP pc that demographic transition formed the urban economy as we know it today even till recently, children was the main source of cheap labor in societies  The “city family” did not rely on the labor of its children for prosperity:  When the GDP pc would fall below the subsistence level, famine, war, child  Children had turned from assets to liabilities mortality would “take care” of the over-population “problem”  The “large family” ideal was displaced by a “smart family” model. the decrease in population would make GDP pc to climb to the subsistence level  Technology was what enabled us to break away from the Malthusian cycle © 2019 Kosmas Marinakis, SMU Lecture 8 17 © 2019 Kosmas Marinakis, SMU Lecture 8 18 17 18  History of Growth History of Growth The Industrial Revolution R&D investment today  Industrial Revolution designates the introduction of many new machines and  The most important foundation of growth has been research and development methods of production in Britain (R&D) activity in order to improve our knowledge base starting in textile manufacturing and spreading to other sectors undertaken by firms, universities and governments  It was the first time technology and scientific methods were used in production  Leading countries invest large portion of GDP on R&D (PPP): in such a coordinated manner  Israel: 4.9% ($19 billion)  Today’s rich countries are those that have managed to achieve steady growth  Japan: 3.15% ($166 billion) rates over the past 200 years  United States: 2.74% ($511 billion) are also those that have managed to benefit from the Industrial Revolution  China: 2.19% ($553 billion)  The sustained growth we observe today started with the Industrial Revolution in  Singapore: 2.19% ($10 billion). the 1800s in Britain  To a large extent, our high standards of living today are the returns of some past R&D investment © 2019 Kosmas Marinakis, SMU Lecture 8 19 © 2019 Kosmas Marinakis, SMU Lecture 8 20 19 20 Inequality and poverty Inequality within countries  The fact that an economy is growing does not necessarily imply that all citizens are benefiting equally  In fact, economic growth is often associated with increasing inequality because only part of the workers and businesses benefit from the new technologies INEQUALITY AND POVERTY which drive the growth © 2019 Kosmas Marinakis, SMU Lecture 8 22 21 22 Inequality and poverty Inequality and poverty GDP of the top 10% in Singapore Inequality and poverty 45%  GDP per capita does not reveal much for the distribution of income in a given society 42.5%  Consider two economies: 40%  A: Half population makes $50,000 and the other half $1,000  B: Half population makes $10,000 and the other half $500 37.5%  Which has higher inequality? 35%  Which is more likely to have a poverty problem? 32.5%  Poverty, as defined by the World Bank, is those who live below the $1.25 per day 30%  In Singapore there is no official poverty line income 1975 1980 1985 1990 1995 2000 2005 2010 2015  © 2019 Kosmas Marinakis, SMU Lecture 8 23 © 2019 Kosmas Marinakis, SMU Lecture 8 24 23 24  Inequality and poverty Poverty policies  There are no silver-bullet policies for reducing poverty around the world  Nevertheless, economics suggests potentially useful approaches:  International trade, for instance trading of resources  Improving new technologies, for instance the LED light  Financial aid, for instance foreign scholarships  Direct intervention, for example Venezuela, Iraq THE SOLOW MODEL © 2019 Kosmas Marinakis, SMU Lecture 8 25 25 26 The Solow model The Solow model Aggregate production function The Solow growth model (1956) Aggregate Production Function  The main tool that economists use for formally studying growth of GDP is the  Human capital, physical capital, and technology each play a part in Solow model determining productivity named after the Nobel laureate economist Robert Solow  In general, we assume that GDP increases with:  The Solow model consists of three building blocks:  An increase in the level of technology (𝐴) 1. The aggregate production function  An increase in the physical capital stock (𝐾) 2. The equation for physical capital accumulation  An increase in the amount of work hours (𝐿) 3. The saving by households  An increase in the average skill level of the work force (ℎ).  All of the above can be summarized in the aggregate production function 𝑌 = 𝐴 𝐹(𝐾, 𝐿 ℎ) GDP (𝑌) is equal to the level of technology (𝐴) multiplied by some increasing function 𝐹( ) of the capital (𝐾) and the efficiency of labor (𝐿 ℎ) © 2019 Kosmas Marinakis, SMU Lecture 8 27 © 2019 Kosmas Marinakis, SMU Lecture 8 28 27 28 The Solow model Aggregate production function The Solow model Aggregate production function Changes in aggregate production Micro origins  For example, in the aggregate production function  The aggregate production function is similar to the production function of an 𝑌 =𝐴 𝐾 (𝐿 ℎ) individual firm  Higher 𝑨 implies that more GDP can be produced with the same 𝐾, 𝐿, and ℎ  In particular, according to the aggregate production function: because of better technology 1. GDP is increasing in technology, physical capital and labor 2. GDP increases less and less as we increase physical capital or labor.  Higher 𝑲 allows for the production of more GDP because the economy has more or better machines  This is known as Law of Diminishing Marginal Product the marginal contribution of a factor of production to GDP diminishes when we  Higher 𝑳 allows for the production of more GDP increase the quantity of that factor ceteris paribus because the economy has more workers (increase in labor force, immigration etc.)  Higher 𝒉 increases the production of GDP because workers are more productive (education, international talent recruitment) © 2019 Kosmas Marinakis, SMU Lecture 8 29 © 2019 Kosmas Marinakis, SMU Lecture 8 30 29 30  The Solow model Aggregate production function The Solow model Capital accumulation Aggregate production function – graph Physical capital accumulation  The figure illustrates the relationship Y  Production factors are durable and subject to depreciation Increase in A between the level of capital, 𝐾, and the total 𝑌 𝒀’  Depreciation erodes the value of physical capital, but it can be alleviated by production 𝑌 continual investment and upkeep  If 𝑨 improves, the curve shifts upwards 𝑌 𝒀  If capital depreciates at rate 𝒅 per year: with the same 𝑲 more 𝒀 can be produced next year’s capital = (1 − 𝑑) of this year’s capital + this year’s investment  If, for instance, capital this year is $100, it depreciates at 12% per year and this year we invested $15 in capital, next year’s capital will be: 1 − 0.12 $100 + $15 = $103 we lost $12 due to depreciation but we over-covered the loss with new investment of 𝐾 K $15, so next year the capital stock will increase by $3 © 2019 Kosmas Marinakis, SMU Lecture 8 31 © 2019 Kosmas Marinakis, SMU Lecture 8 32 31 32 The Solow model Household saving The Solow model Household saving Household saving Saving decision  The expenditure identity for GDP is 𝑌 = 𝐶 + 𝐼 + 𝐺 + (𝑋 − 𝑀)  Saving is a way of allocating some of today’s resources to future consumption  If for simplicity we consider:  Each household typically faces different priorities and needs that influence their  A closed economy (𝑋 = 𝑀 = 0) consumption – saving allocation  And no government spending (𝐺 = 0). for example, parents may save for their children for college  GDP expenditure equals consumption plus investment:  The allocation of household income between consumption and saving should be 𝑌=𝐶+𝐼 affected by the interest rate  Also, household income is split between consumption (𝐶) and saving (𝑆): the rate of return households expect on their savings 𝑌 =𝐶+𝑆  Higher interest rates encourage saving  In other words, income households save is allocated to firms as investment:  On the other hand, expectation of high future growth discourages saving 𝐼 = 𝑆 © 2019 Kosmas Marinakis, SMU Lecture 8 33 © 2019 Kosmas Marinakis, SMU Lecture 8 34 33 34 The Solow model Household saving The Solow model Steady state Aggregate saving Saving vs. depreciation  Here we will assume that the households Y  Capital (𝐾) depreciates at rate 𝒅 Y save a predetermined fraction 𝒔 of their we illustrate depreciation with 𝑑 𝐾 income 𝒀  At point A, depreciation equals investment 𝒀 Saving rate Total saving  Thus: Consumption this occurs at capital 𝐾 ∗ E 𝒅 𝑲 (1 − 𝑠) 𝑌 Excess 𝑆=𝑠 𝑌  For capital 𝐾 below 𝐾 : ∗ depreciation 𝒔 𝒀 A 𝒔 𝒀 C  Then, because 𝐼 = 𝑆, investment in the  Investment (at C) exceeds depreciation (at B) D economy will be:  Thus, next year capital will be higher. Investment 𝐼=𝑠 𝑌 B / Saving  For capital 𝐾 above 𝐾 ∗ : 𝑠 𝑌  Depreciation (at E) exceeds investment (at D)  Thus, capital next year will fall K  𝐾 𝐾∗ 𝐾 K © 2019 Kosmas Marinakis, SMU Lecture 8 35 © 2019 Kosmas Marinakis, SMU Lecture 8 36 35 36  The Solow model Steady state The Solow model Steady state Steady state Increase in technology  Below 𝐾 ∗ , capital next year will increase, Y  An increase in technology will shift upwards Y C’ 𝑌∗ 𝒀′ and thus, GDP will increase, too the production curve to 𝑌′ A’ A’ the economy will have positive growth rate 𝑌∗ 𝒀  Consequently, the saving / investment 𝑌∗ 𝒀  Above 𝐾 ∗ , capital next year will decrease, E 𝒅 𝑲 curve will shift upwards to 𝑠 𝑌′ B C 𝒅 𝑲 Excess 𝒔 𝒀′ and thus, GDP will decrease, too depreciation  At 𝐾 ∗ , now there is excess investment AB, A 𝒔 𝒀 A 𝒔 𝒀 the economy will have negative growth rate C D which will cause capital to start increasing  At 𝐾 ∗ , capital remains constant, and thus,  The steady state moves at C with 𝐾 and 𝑌 ∗ ∗ GDP will remain constant, too B  Technology can increase the maximum the economy will have zero growth rate sustainable size of an economy ∗ ∗  𝐾 and 𝑌 is the steady state equilibrium the maximum sustainable size of an economy 𝐾 𝐾∗ 𝐾 K 𝐾∗ 𝐾∗ K © 2019 Kosmas Marinakis, SMU Lecture 8 37 © 2019 Kosmas Marinakis, SMU Lecture 8 38 37 38 The Solow model Steady state The Solow model Steady state Increase in saving rate Increase in depreciation rate  An increase in the saving rate will not affect Y  An increase in the depreciation rate will not Y the production curve affect the production curve neither the the 𝑌∗ C’  Only the saving / investment curve will 𝑌∗ 𝒀 saving / investment curve 𝑌∗ 𝒀 A’ 𝑌∗ A’ C’ 𝒅′ 𝑲 shift upwards to 𝑠′ 𝑌 B C 𝒅 𝑲  Instead, it will rotate inwards the B 𝒅 𝑲 𝒔′ 𝒀  At 𝐾 ∗ , now there is excess investment AB, depreciation curve A 𝒔 𝒀 A 𝒔 𝒀 C which will cause capital to start increasing  At 𝐾 ∗ , now there is excess depreciation AB,  The steady state moves at C with 𝐾 ∗ and 𝑌 ∗ which will cause capital to start decreasing  Saving habits can also increase the  The steady state moves at C with 𝐾 ∗ and 𝑌 ∗ maximum sustainable size of an economy  Increase in depreciation rate decreases the but not as drastically as technology maximum sustainable size of an economy 𝐾∗ 𝐾∗ K 𝐾∗ 𝐾∗ K © 2019 Kosmas Marinakis, SMU Lecture 8 39 © 2019 Kosmas Marinakis, SMU Lecture 8 40 39 40 Causes of prosperity Causes of prosperity  Why some countries:  accumulate more physical capital,  invest more in human capital,  research and develop more in technology than other countries? CAUSES OF PROSPERITY  If all those factors improve GDP, why do not all countries in the world invest in those?  Why is not the whole world as developed as the developed countries? © 2019 Kosmas Marinakis, SMU Lecture 8 42 41 42  Causes of prosperity Causes of prosperity Climate Geography  Growth is affected by climactic or ecological conditions outside of the nations  Growth is affected by geographical or geopolitical conditions also outside of control: the nations control:  Inhospitable area for agriculture  Suitability of the terrain for building infrastructure  Hospitable conditions for diseases  Navigable rivers for transportation  Daytime temperatures prohibit intense labor.  Access to the sea  Such conditions may render impossible for such countries to accumulate or  Possible cooperation with neighboring countries effectively use the factors of production  Existence of natural resources © 2019 Kosmas Marinakis, SMU Lecture 8 43 © 2019 Kosmas Marinakis, SMU Lecture 8 44 43 44 Causes of prosperity Causes of prosperity Culture Institutions  Growth is affected by cultural elements:  Institutions are the formal and informal rules governing the organization of a  Specific shared experiences society  Strength of family ties including its laws and regulations  Religious teachings  They are “humanly devised” constraints on behavior that are at the root of  Attitude towards commonwealth the differences in prosperity  Strength of national identity.  Differences in institutions shape the economic incentives that individuals and  Some societies may have values that encourage investment, hard work, and businesses in the society face: the adoption of new technologies  Allocation of human capital to occupations  Others may nurture superstition and suspicion of new technologies and  Rules that encourage investment in capital and R&D discourage hard work  Protection of rights  Consistency in regulation © 2019 Kosmas Marinakis, SMU Lecture 8 45 © 2019 Kosmas Marinakis, SMU Lecture 8 46 45 46 Causes of prosperity History and luck  Nations often tend to follow on the steps of their ancestors  Countries develop traditions in different areas of production that may or may not be Thank you! found in high demand…  Also, not unusually, the winners of wars and conflicts –often due to mere luck– [email protected] are the ones who take advantage of the www.kmarinakis.org t.me/kosmas_teaching losers to grow Kosmas Marinakis Kosmas Marinakis @Kos_Marinakis © 2019 Kosmas Marinakis, SMU Lecture 8 47 kosmas_marinakis 47 48  WARNING! FYI-1 The slides in this handout are created This handout is provided in.pdf form because the original with the intention to serve a visual aid presentation is a large file, requires specific software to for the audience during the live run the animations and may not be executable in most presentation of the material in the presentation clients. lecture. As such, they are not designed to be standalone reading material and should be used strictly as reference, side by side with notes FYI-2 taken in the lecture. Studying solely Slides are purposely made available to students after the from the slides is not recommended lecture because they are designed to be the first contact and might in some cases mislead point for students with the topics. These slides are carefully those who have not attended the animated to point the attention, to stimulate student relevant lecture. Less than 5% of interest and to enable a high-energy presentation. Access tasks in test and exam can be to the slides ahead of time, would severely deteriorate the answered solely from the slides. quality of the delivery of the relevant material in class. 49