3.Economic Growth

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Chapter 3Economic Growth:

Theory and Policy

Once one starts to think about . . . [differencesin 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

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 Given technology & labor force

Better technology Given capital & labor

Workforce quality More education & training Given capital, technology, labor force

Human capital (education & training)

Amount of skill workforce 3


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Production functions corresponding to three different capital stocks

Figure 1

4

0

Hours of Labor Input

Output

L1

YaK1

Yb

YcK2

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 Workforce skills

Technology 5


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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.)

Growthrate

United StatesFranceUnitedKingdomSpainIreland

ArgentinaMexicoBrazilSouth Korea

1008671625751

443320

1009985629637

252348

1.72.32.41.73.90.4

-0.50.25.4


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Levels, Growth Rates, & Convergence Convergence 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

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0 Time

RealGDPpercapita

$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

Existing technologies Convergence club

Productivity growth rates - higher Where productivity levels are lower

Poorest nations Unable to join

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Levels and growth rates of GDP per capita in selected poor countries

Table 2

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Country GDP percapita2005*

GDP per capita growthrate,

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 Nations 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 time11


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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

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Choosing between investment and consumption

Figure 3

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0Consumer Goods Produced

InvestmentGoodsProduced

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 States

CanadaUnited Kingdom JapanMexicoIndiaSweden

BrazilItalyChinaSwaziland

9.38.3

8.38.07.06.06.05.7

5.35.05.02.3


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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

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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

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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, 19482007

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 & multinationalinstitutions

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 Korea

JapanUnited KingdomItalyMexicoIndiaBrazilSudan

12.311.410.59.79.47.06.74.84.61.9

For people older than 25 yearsof 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

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3.Economic Growth

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