Economic growth and Economic growth and living standardsliving standards

Long-Term Growth Trends (US)Long-Term Growth Trends (US)

Long-Term Growth TrendsLong-Term Growth Trends

Many developing Many developing countries in Africa, Central countries in Africa, Central America, and South America, and South America stagnated during America stagnated during the 1980s, and have grown the 1980s, and have grown slowly since.slowly since.They have fallen further They have fallen further behind the United States.behind the United States.

Long-Term Growth TrendsLong-Term Growth Trends

Other formerly low-Other formerly low-income nations—Hong income nations—Hong Kong, Korea, Singapore, Kong, Korea, Singapore, and Taiwan are examplesand Taiwan are examples—have grown very rapidly —have grown very rapidly and have caught up or are and have caught up or are catching up with the catching up with the United StatesUnited States

The problem of economic The problem of economic developmentdevelopment

Lucas defines it as the problem of Lucas defines it as the problem of accounting for the observed pattern, accounting for the observed pattern, across countries and across time, in levels across countries and across time, in levels and rates of growth of per capita GDPand rates of growth of per capita GDP

Motivation: The diversity across countries Motivation: The diversity across countries in per capita income is too great to be in per capita income is too great to be believedbelieved

The problem of economic The problem of economic development (contd)development (contd)

Is there some action the govmt of India could Is there some action the govmt of India could take to grow as Japan? If so, what exactly? If take to grow as Japan? If so, what exactly? If not, what is it about the nature of India that not, what is it about the nature of India that makes it somakes it so

Consequences for human welfare are Consequences for human welfare are staggering. Once one starts to think about them, staggering. Once one starts to think about them, it is hard to think about anything else!it is hard to think about anything else!

Alternative measures of development Alternative measures of development

United Nations Development Programme: United Nations Development Programme: Development is about expanding the choices people Development is about expanding the choices people have to lead lives that they valuehave to lead lives that they value

The most basic things for human development are:The most basic things for human development are: To lead long and healthy livesTo lead long and healthy lives Be knowledgeableBe knowledgeable Have resources for a decent standard of livingHave resources for a decent standard of living Participate in the communityParticipate in the community

Very different income, similar HDIVery different income, similar HDI

Our approachOur approach

Accounting for differences in GDP is not Accounting for differences in GDP is not the only thing that mattersthe only thing that matters

But it certainly is an important one (no But it certainly is an important one (no extremely poor country has a high HDI)extremely poor country has a high HDI)

In the long-run small differences in In the long-run small differences in growth rates matter a lotgrowth rates matter a lot

Australia was much richer than Japan in 1870Australia was much richer than Japan in 1870

Over 1870-2000 Japan grew at an annual rate of Over 1870-2000 Japan grew at an annual rate of 2.5%, while Australia grew at 1.1%2.5%, while Australia grew at 1.1%

As a result, Japan is now richer than AustraliaAs a result, Japan is now richer than Australia

What happens to GDP under What happens to GDP under different growth rates?different growth rates?

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

5

0 10 20 30 40 50 60

Series growing at 2.5% Series growing at 1.0%

Why some countries are rich and some Why some countries are rich and some countries are poor (at one point in time)?countries are poor (at one point in time)?

What is the engine driving economic What is the engine driving economic growth (what is the force driving the time growth (what is the force driving the time series behavior of GDP)?series behavior of GDP)?

Important questionsImportant questions

MethodologyMethodology

First: accounting decompositionFirst: accounting decomposition

Identify what makes GDP to be so different across Identify what makes GDP to be so different across distinct countriesdistinct countries

Once we identify the force driving the cross-country Once we identify the force driving the cross-country disparity we can develop more effective economic disparity we can develop more effective economic policies and better economic modelspolicies and better economic models

Growth accountingGrowth accounting

GDP is quantity of goods produced in a GDP is quantity of goods produced in a given periodgiven period

What determines how many goods can be What determines how many goods can be produced?produced?

Inputs and technical constraintsInputs and technical constraints

InputsInputs Labor (L)Labor (L) Machines (capital stock = K)Machines (capital stock = K)

Technical constraints Technical constraints Statistical studies suggest Statistical studies suggest

gives a good representation of the aggregate technical gives a good representation of the aggregate technical capabilities of an economy (where Y is maximum capabilities of an economy (where Y is maximum output possible given inputs K and L, and output possible given inputs K and L, and is a is a positive number smaller than one)positive number smaller than one)

Y AK L1

Accounting for the observed Accounting for the observed differences in output per workerdifferences in output per worker

Growth accounting divides growth in output per Growth accounting divides growth in output per worker in two componentsworker in two components Growth in capital per hour of labor (K/L)Growth in capital per hour of labor (K/L) Technological change (A)Technological change (A)

Implication of the above formula: Any growth not Implication of the above formula: Any growth not accounted for by growth in capital is allocated to accounted for by growth in capital is allocated to technological change, so this category is a broad technological change, so this category is a broad catchall concept.catchall concept.

ALP YL AK L1

L AK L1

L L1 A KL

ConclusionsConclusions

That different countries have different That different countries have different levels (or growth rates) of output per levels (or growth rates) of output per worker can only be due to worker can only be due to Differences in the level (or growth) of Differences in the level (or growth) of

capital per worker (K/L)capital per worker (K/L) or differences in TFPor differences in TFP

What is more important?What is more important? Empirical question that can only be Empirical question that can only be

answered by looking at each country’s answered by looking at each country’s datadata

Growth Accounting (intuitive Growth Accounting (intuitive graphical view)graphical view)

Productivity Curve: relationship between Productivity Curve: relationship between real GDP per hour of labor and the amount real GDP per hour of labor and the amount of capital per hour of labor, with technology of capital per hour of labor, with technology held constant.held constant.

Growth AccountingGrowth AccountingAn increase in capital per An increase in capital per hour brings a movement hour brings a movement along productivity curve.along productivity curve.

Technological change Technological change shifts the productivity shifts the productivity curve. curve.

Only two things matter:Only two things matter:

Capital per hour, and Capital per hour, and technological changetechnological change

Growth AccountingGrowth AccountingThe shape of the productivity curve reflects the law of The shape of the productivity curve reflects the law of diminishing returns.diminishing returns.

The The law of diminishing returnslaw of diminishing returns states that, as the states that, as the quantity of one input increases with the quantities of all quantity of one input increases with the quantities of all other inputs remaining the same, output increases but other inputs remaining the same, output increases but ever smaller increments.ever smaller increments.

Diminishing returnsDiminishing returns

One third rule (empirical regularity)One third rule (empirical regularity) Robert Solow discovered that diminishing returns Robert Solow discovered that diminishing returns

are well described by the are well described by the one-third ruleone-third rule: with no : with no change in technology, on the average, a 1 percent change in technology, on the average, a 1 percent increase in capital per hour of work brings a increase in capital per hour of work brings a one-one-third of 1 percentthird of 1 percent increase in output per hour of increase in output per hour of labor.labor.

Example: Assume technology remains fixed and Example: Assume technology remains fixed and the capital stock of the US economy increases by the capital stock of the US economy increases by 30%, what would you expect will happen to output 30%, what would you expect will happen to output per hour as a result of this increase in capital?per hour as a result of this increase in capital?

Growth Accounting: An Growth Accounting: An application to the US economyapplication to the US economy

The productivity function and one-third rule can The productivity function and one-third rule can be used to study productivity growth in the United be used to study productivity growth in the United States.States.

Growth AccountingGrowth Accounting

From 1963 to 1973 a From 1963 to 1973 a large increase in large increase in productivity (output per productivity (output per hour) resulted from rapid hour) resulted from rapid technological change and technological change and a modest increase in a modest increase in capital per worker.capital per worker.

Growth AccountingGrowth Accounting

From 1973 to 1983 From 1973 to 1983 productivity growth productivity growth slowed because the pace slowed because the pace of technological change of technological change slowed down.slowed down.

Capital per worker Capital per worker continues to grow at a continues to grow at a similar pace to that of the similar pace to that of the previous decade.previous decade.

How to achieve faster growth: conclusions How to achieve faster growth: conclusions from the graphical approachfrom the graphical approach

Growth accounting tell us that to achive Growth accounting tell us that to achive faster economic growth we must either faster economic growth we must either increase the growth rate of capital per hour increase the growth rate of capital per hour of labor or increase the pace of technological of labor or increase the pace of technological advance.advance.

What policies may achieve faster growth?What policies may achieve faster growth?

Resources are scarceResources are scarce

Objective now: determine which policy will Objective now: determine which policy will have the largest positive impact on GDP have the largest positive impact on GDP per person (or on its growth rate).per person (or on its growth rate).

Data + quantitative analysis are required Data + quantitative analysis are required to answerto answer

Growth accounting (quantitative Growth accounting (quantitative apporach)apporach)

One simple tool. Use the properties of One simple tool. Use the properties of logarithms. In particular recall thatlogarithms. In particular recall that

ln(x)-ln(y) percentage ln(x)-ln(y) percentage differencebetween x and ydifferencebetween x and y

Example: If ln(GDP1)-ln(GDP2)=0.02 that Example: If ln(GDP1)-ln(GDP2)=0.02 that means GDP1 is approximately 2% larger means GDP1 is approximately 2% larger than GDP2than GDP2

Accounting for cross-country ALP Accounting for cross-country ALP disparitydisparity

ALPcountry x Acountry x Kcountry x

Lcountry x

thus

lnALPcountry x ln Acountry x Kcountry x

Lcountry x

finally ,

lnALPcountry x lnAcountry x ln Kcountry x

Lcountry x

Accounting for cross-country Accounting for cross-country ALP disparityALP disparity

Substract from both sides of

lnALPcountry x lnAcountry x ln Kcountryx

Lcountryx

the same equation, but applied to country y

lnALPcountry x lnALPcountry y lnAcountry x lnAcountry y

ln Kcountryx

Lcountryx ln Kcountryy

Lcountryy

Which in words means:Percentage difference between x and y’s ALP = Percentage difference between x and y’s TFP + *(percentage difference between x and y’s capital)