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Robert Lucas • "Is there some action a government of India could take that would lead the Indian Economy to grow like Indonesia’s or Egypt’s? If so, what exactly? If not, what is it about the “nature of India” that makes it so? The consequences for human welfare involved in questions like these are simply staggering: Once one starts to think about them it is hard to think of anything else.
Why is Growth important? • Measures of Welfare • http://www.gapminder.org/index.html
Economic Growth from 1,000,000 B.C. to the Present World economic growth was essentially zero in the years before 1300, and it was very slow—an average of only 0.2 percent per year—before 1800. The Industrial Revolution made possible the sustained increases in real GDP per capita that have allowed some countries to attain high standards of living.
Long-Run Growth • Economic growth refers to an increase in the total output of an economy. Defined by some economists as an increase of real GDP per capita.
Long-Run Growth • Modern economic growth is the period of rapid and sustained increase in real output per capita that began in the Western World with the Industrial Revolution.
The Growth Process:From Agriculture to Industry • The production possibility frontier (ppf) shows all the combinations of output that can be produced if all society’s scarce resources are fully and efficiently employed. • Economic growth expands society’s production possibilities, shifting the ppf up and to the right.
The Growth Process:From Agriculture to Industry • Before the Industrial Revolution in Great Britain, every society in the world was agrarian. • Beginning in England around 1750, technical change and capital accumulation increased productivity in two important industries: agriculture and textiles. • More could be produced with fewer resources, leading to new products, more output, and wider choice.
The Sources of Economic Growth • An aggregate production function is the mathematical representation of the relationship between inputs and national output, or gross domestic product.
The Sources of Economic Growth • If you think of GDP as a function of both labor and capital, you can see that an increase in GDP can come about through: • An increase in the labor supply • An increase in physical or human capital • An increase in productivity (the amount of product produced by each unit of capital or labor)
An Increase in Labor Supply • An increasing labor supply can generate more output, but if the capital stock remains fixed, the new labor will be less productive (diminishing returns).
An Increase in Labor Supply • Malthus and Ricardo predicted a gloomy future as population outstripped the land’s capacity to produce. However, they forgot the impact of technological change and capital accumulation.
An Increase in Labor Supply • Growth in the labor force, without a corresponding increase in the capital stock or technological change, might lead to growth of output but declining productivity and a lower standard of living.
An Increase in Labor Supply • Labor productivity is the output per worker hour; the amount of output produced by an average worker in 1 hour.
An Increase in Labor Supply • As long as the economy and the capital stock are expanding rapidly enough, new entrants into the labor force do not displace other workers.
Increases in Physical Capital • An increase in the stock of capital can increase output, even if it is not accompanied by an increase in the labor force.
Increases in Physical Capital • The increase in capital stock is the difference between gross investment and depreciation. • Capital has been increasing faster than the labor force since 1960. When capital expands more rapidly than labor, the ratio of capital to labor (K/L) increases, and this too is a source of increasing productivity.
Increases in Productivity • Growth that cannot be explained by increases in the quantity of inputs can be explained only by an increase in the productivity of those inputs.
Increases in Productivity • The productivity of an input is the amount produced per unit of an input. • Factors that affect the productivity of an input include technological change, other advances in knowledge, and economies of scale.
Increases in Productivity • Technological change affects productivity in two stages: • First there is an advance in knowledge, or an invention. • Then there isinnovation, or the use of new knowledge to produce a new product or to produce an existing product more efficiently. • There are capital-saving innovations, and labor-saving innovations.
Increases in Productivity • External economies of scale are cost savings that result from increases in the size of industries. • Production abatement requirements divert capital and labor from the production of measured output, therefore reducing measured productivity.
Labor Productivity: 1952 – 2003 • Some of the explanations for the slowdown in productivity growth in the 1970s include: • A low rate of saving • Increased environmental and government regulations • Lack of spending in R&D • High energy costs
Labor Productivity: 1952 – 2003 • Many of these factors turned around in the 1980s and 1990s, yet productivity growth remained low.
Economic Growth and Public Policy • Policy provisions to improve the quality of education include the new Education Individual Retirement Account that allows savings to earn tax free returns as long as the balance is used to pay for educational expenses.
Economic Growth and Public Policy • Policies to increase the saving rate include individual retirement accounts that accumulate earnings without paying income tax.
Economic Growth and Public Policy • The amount of capital accumulation is ultimately constrained by its rate of saving. • The tax system and the social security system in the United States are biased against saving.
Economic Growth and Public Policy • Some public finance economists favor shifting to a system of consumption taxation rather than income taxation to reduce the tax burden on saving.
Economic Growth and Public Policy • Other public policies to stimulate economic growth include: • Policies to stimulate investment • Policies to increase research and development • Reduced regulations • Industrial policy, or government involvement in the allocation of capital across manufacturing sectors.
The Pro-growth Argument • Advocates of growth believe growth is progress. • New technologies and production methods lead to new and better products. Capital accumulation and new technology improve the quality of life.
The Progrowth Argument • Growth saves the most valuable commodity—time. • Growth also improves the quality of things that yield satisfaction directly.
The Progrowth Argument • Growth produces jobs and higher incomes. With higher incomes we can better afford the sacrifices needed to help the poor. • When population growth is not accompanied by growth in output, unemployment and poverty increase.
The Antigrowth Argument • Growth has negative effects on the quality of life. • Growth encourages the creation of artificial needs. • Consumer sovereignty is the notion that people are free to choose, and that things that people do not want will not sell. “The consumer rules.”
The Anti-growth Argument • Growth means the rapid depletion of a finite quantity of resources. • Growth requires an unfair income distribution and propagates it.
Nature’s Inequalities • Geography • Institutions matter(Daron Acemoglu) • Solow’s Surprise • Capital matters, but only to a point. • Growth comes from Technology (productivity)
Economic Growth in Developingand Transitional Economies • The universality of scarcity makes economic analysis relevant to all nations. • Economic problems and policy instruments are different, but economic thinking about these problems can be transferred easily from country to country.
