economic growth. the world economy total gdp: $31.5t gdp per capita: $5,080 population growth: 1.2%...

Economic Growth

The World Economy

• Total GDP: $31.5T• GDP per Capita:

$5,080• Population Growth:

1.2%• GDP Growth: 1.7%

The World Economy by Region

Region GDP GDP per cap

Pop Growth

GDP Growth

Sub-Saharan Africa $318B $450 2.2% 3.2%

East Asia & Pacific $1.8T $950 .9% 6.7%

Middle East & N. Africa

$693B $2,220 2% 3.2%

Europe & C. Asia $1.1T $2,160 .1% 4.7%

South Asia $655B $450 1.7% 4.3%

Latin America $1.7T $3,280 1.5% -.5%

US vs. Europe

United States

GDP: $10.1T

GPD/Capita: $35,500

Pop Growth: .9%

GDP Growth: 2.1%

European Union

GDP: $6.6T

GDP/Capita: $20,230

Pop Growth: .2%

GDP Growth: .7%

High Income vs. Low Income Countries

• As a general rule, low income (developing) countries tend to have higher average rates of growth than do high income countries

Income vs. Growth

Income GDP/Capita Pop Growth

GDP Growth

Low $430 1.7% 4.1%

Middle $1,840 .9% 3.2%

High $26,310 .5% 1.3%



• However, this is not always the case

Exceptions to the Rule

Haiti

GDP/Capita: $440

Pop Growth: 1.8%

GDP Growth: -.9%

Hong Kong (China)

GDP/Capita: $24,750

Pop Growth: .8%

GDP Growth: 2.3%



• However, this is not always the case

• So, what is Haiti doing wrong? (Or, what is Hong Kong doing right?)

Sources of Economic Growth

• Recall, that we assumed three basic inputs to production– Capital (K)– Labor (L)– Technology (A)

Growth Accounting

Step 1: Estimate capital/labor share of income

K = 30%

L = 70%

Growth Accounting


K = 30%

L = 70%

Step 2: Estimate capital, labor, and output growth

%Y = 5%

%K = 3%

%L = 1%

Growth Accounting


K = 30%

L = 70%


%Y = 5%

%K = 3%

%L = 1%

Productivity growth will be the residual output growth after correcting for inputs

Growth Accounting


K = 30%

L = 70%


%Y = 5%

%K = 3%

%L = 1%


%A = %Y – (.3)*(%K) – (.7)*(%L)

Growth Accounting


K = 30%

L = 70%


%Y = 5%

%K = 3%

%L = 1%


%A = %Y – (.3)*(%K) – (.7)*(%L)

%A = 5 – (.3)*(3) + (.7)*(1)

= 3.4%

Sources of US Growth

1929 - 1948 1948 - 1973 1973-1982 1982-1997

Output 2.54 3.70 1.55 3.45

Capital .11 .77 .69 .98

Labor 1.42 1.40 1.13 1.71

Total Input 1.53 2.17 1.82 2.69

Productivity 1.01 1.53 -.27 .76

The Solow Model of Economic Growth

• The Solow model is basically a “stripped down” version of our business cycle framework (labor markets, capital markets, money markets)– Labor supply (employment) is a constant

fraction of the population ( L’ = (1+n)L )– Savings is a constant fraction of disposable

income: S = a(Y-T)– Cash holdings are a constant fraction of income

(velocity is constant)

The Solow Model

• Labor Markets

– (w/p) = MPL(A,K,L)

– L’ = (1+n)L

– Y = F(A,K,L) = C+I+G

The Solow Model• Labor Markets


– L’ = (1+n)L

– Y = F(A,K,L) = C+I+G

• Capital Markets

– r = (Pk/P)(MPK(A,K,L) – d)

– S = I +(G-T)

– K’ = K(1-d) + I

The Solow Model• Labor Markets


– L’ = (1+n)L

– Y = F(A,K,L) = C+I+G

• Capital Markets

– r = (Pk/P)(MPK(A,K,L) – d)

– S = I +(G-T)

– K’ = K(1-d) + I

• Money Markets

– M = PY

The Solow Model

• Step #1: Convert everything to per capita terms (For Simplicity, Technology Growth is Left Out)– x = X/L

Properties of Production

• Recall that we assumed production exhibited constant returns to scale

• Therefore, if Y = F(K,L), the 2Y = F(2K,2L)

• In fact, this scalability works for any constant





Y = F(K,L)

(1/L)Y = F((1/L)K, (1/L)L)

Y/L = F(K/L, 1) = F(K/L)

y = F(k)





Y = F(K,L)

(1/L)Y = F((1/L)K, (1/L)L)

Y/L = F(K/L, 1) = F(K/L)

y = F(k)

MPL is increasing in k

MPK is decreasing in k

Labor Markets

• w/p = MPL(k) and MPL is increasing in k

• y = F(k) = c + i + g

• L’ = (1+n)L

Capital Markets

• r = MPK(k) – d with MPK declining in k

• s = i + (g-t) = a(y-t) = a(F(k)-t)

• k’(1+n) = k(1-d) + i

The Solow Model

• Step #1: Convert everything to per capita terms (For simplicity, Technology Growth is left out)– x = X/L

• Step #2: Find the steady state– In the steady state, all variables are constant.

Steady State Investment

• In the steady state, the capital/labor ratio is constant. (k’=k)

k’(1+n) = (1-d)k + i

Steady State Investment:


k’(1+n) = (1-d)k + i

k(1+n) = (1-d)k + i

Steady State Investment


k’(1+n) = (1-d)k + i

k(1+n) = (1-d)k + i

Solving for i gives is steady state investment

i = (n+d)k

Steady State Investment n =.20, d = .10

0

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Investment

Steady State Output/Savings

• Given the steady state capital/labor ratio, steady state output is found using the production function

y = F(k)

• Recall that MPK is diminishing in k

Steady State Output

050

100150200250300350400450500

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output

Steady State Net Income (t=100)

050

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outputnet income

Steady State Savings (a=.05)

050

100150200250300350400450500

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OutputNet incomeSavings

In Equilibrium, (g-t)=0. Therefore, s=i

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InvestmentSavings

Steady State

• In this example, steady state k (which is K/L) is 50.

• Steady state investment (i) = steady state savings(s) = 15

• Steady state output (y) equals F(50) = 400

• Steady state government spending (g) = steady state taxes (t) = 100

• Steady state consumption = y – g – i = 285

• Steady state factor prices come from firm’s decision rules:– W/P = MPL(k) , r = MPK(k) – d

• The steady state price level (P) = M/Y

Growth vs. Income

• Suppose that the economy is currently at a capital/labor ratio of 20.


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InvestmentSavings

Growth vs. Income


– Investment = Savings = 7.5. This is higher than the level of investment needed to maintain a constant capital stock (6).

– With the extra investment, k will grow.

– As k grows, wages will rise and interest rates will fall.

Growth vs. Income


– Investment = Savings = 7.5. This is higher than the level of investment needed to maintain a constant capital stock (6).

– With the extra investment, k will grow.

– As k grows, wages will rise and interest rates will fall.

• Suppose the economy is at a capital/labor ratio of 70.


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InvestmentSavings

Growth vs. Income

• Suppose that the economy is currently at a capital/labor ratio of 20.– Investment = Savings = 7.5. This is higher than the

level of investment needed to maintain a constant capital stock (6).

– With the extra investment, k will grow.– As k grows, wages will rise and interest rates will fall.

• Suppose the economy is at a capital/labor ratio of 70.– Investment = Savings = 6.5. This is less than the

investment required to maintain a constant capital stock. – Without sufficient investment, the economy will shrink.– As k falls, interest rates rise and wages fall.

Growth vs. Income

• Poor (developing) countries (low capital/income ratio) are below their eventual steady state. Therefore, these countries should be growing rapidly

• Wealthy (developed) countries (high capital/labor ratio) are at or above their eventual steady state. Therefore, these countries will experience little or no growth.

Growth vs. Income



• The implication is that we will all end up in the same place eventually. This is known as absolute convergence

Growth vs. Income



• The implication is that we will all end up in the same place eventually. This is known as absolute convergence

• So, what’s wrong with Haiti?

Conditional Convergence

• Our previous analysis is assuming that every country will eventually end up at the same steady state. Suppose that this is not the case.

For example, suppose that a country experiences a decline in population growth. How is the steady state affected?

A Decline in Population Growth

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n=20Savings

A Decline in Population Growth

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n=20Savingsn=10

Conditional Convergence

• Our previous analysis is assuming that every country will eventually end up at the same steady state. Suppose that this is not the case.

For example, suppose that a country experiences a decline in population growth. How is the steady state affected?

• With a lower population growth, the steady state increases from 50 to 85. With an increase in the steady state, this country finds itself further away from its eventual ending point. Therefore, growth increases.

• Conditional convergence states that a country’s growth rate is proportional to the distance from that county’s steady state

Another Example

• Suppose that savings rate in a country declines. How is the steady state effected?

A Decline in the Savings Rate

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a=.05n=10

A Decline in the Savings Rate

0

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a=.045a=.05n=10

Another Example

• Suppose that savings rate in a country declines. How is the steady state effected?

• With a lower steady state (the steady state falls from 85 to 75), the country finds itself closer to its finishing point. Therefore, its growth rate falls.

Possible Income/Growth Combinations

Growth

Low HighIncome

Low

Haiti

Dem.Rep.Congo

Niger

Zimbabwe

Angola

Bangladesh

China

Ghana

High

Canada

Great Britain

Germany

France

Hong Kong

USA

S. Korea

Malaysia

Low Income/Low Growth Countries

• This combination is a symptom of a very low steady state. Therefore, the solution would be

– Lower Population Growth

– Higher Domestic Savings (Or Open up country to foreign savings)





• Another possibility could be the existence of barriers to capital formation

– Encourage enforcement of property rights.





• Another possibility could be the existence of barriers to capital formation

– Encourage enforcement of property rights.

• Foreign Aid?

High Income/Low Growth Countries

• These countries are probably nearing their (high) steady state. Therefore, recommendations would be:

– Consider lowering size/scope of government

– Promote the development of new technologies

economic growth. the world economy total gdp: $31.5t gdp per capita: $5,080 population growth: 1.2%...

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