Frank & Bernanke 4th edition, 2009

1. Frank & Bernanke4th edition, 2009 Ch. 7: Economic Growth

2. Source: http://www.economist.com/displayStory.cfm?story_id=346598

3. http://www.youtube.com/watch?v=jbkSRLYSojo

5. Can the gross domestic product per capita be used to measure human development instead of the HDI? No. GDP per capita only reflects average national income. It tells nothing of how that income is distributed or how that income is spent - whether on universal health, education or military expenditure. Comparing rankings on GDP per capita and the HDI can reveal much about the results of national policy choices. For example, a country with a very high GDP per capita such as Oman, which has a relatively low level of educational attainment, can have a lower HDI rank than, say, Uruguay, who has roughly 60% of the GDP per capita of Oman.

6. Human development in animation http://hdr.undp.org/en/statistics/data/

7. Real GDP per Person In Selected Countries, 1870-2000 (in 1995 U.S. Dollars) Annual % change 1870-2000 Annual % change 1950-2000 Country 1870 1913 1950 1979 2000 Australia 5,626 7,385 9,561 18,033 24,708 1.1 1.9 Canada 2,447 5,791 9,362 20,899 26,604 1.8 2.1 France 2,249 4,401 6,049 17,801 22,447 1.8 2.6 Germany 1,205 2,320 5,005 18,014 23,247 2.3 3.1 Italy 2,248 3,167 4,042 13,331 21,930 1.8 3.4 Japan 963 1,825 2,216 16,899 24,772 2.5 4.8 United Kingdom 3,500 5,374 7,832 14,889 21,142 1.4 2.0 United States 2,843 6,745 11,921 22,480 32,629 1.9 2.0 Observations 1870: Australia had the highest per capital real GDP and Japan the lowest 2000 real per capita GDP in Japan exceeded Australia Note the difference in the growth rate of 1.1% for Australia and 2.5% for Japan

8. Real GDP per Person in Five Industrialized Countries, 1870 - 2000

9. Compound Interest • Suppose you put $100 in a savings account for your retirement. How much would you have in 50 years? • You need to know the interest rate. • At 1%, the savings at the end of one year will be: 100 + 100*.01 = 100 (1+.01) = 101. • At the end of two years, the savings will be: 100(1.01) + 100(1.01)(.01) = 100(1.01)(1.01) = 100 (1.01)2

10. Compound Interest Observations A small sum compounded over long periods can greatly increase in value Small differences in interest have a very large impact on value

11. Impact on Living Standards • GDP per capita grew at a rate of 2% per year for US during the last 50 years. • Japanese GDP per capita grew at a rate of 5% during the same period. • Chinese GDP per capita grew about 8% per year the last twenty years.

12. Real GDP per Capita • Real GDP per capita is found by dividing the Real GDP by the population: Y/POP. • We can rewrite Y/POP as Y/N times N/POP, since the Ns would cancel out when the two terms are multiplied. • Y/N is average labor productivity. • N/POP is employed portion of the population.

13. Growth Rate of Y/POP • Percentage growth of Y/POP will be equal to percentage growth of Y/N (Average Labor Productivity) PLUS N/POP (Share of population employed). • We can get these numbers for US from government web sites: Bureau of Labor Statistics, Bureau of Economic Analysis, Federal Reserve Bank of St. Louis.

15. US Experience and Forecast • Why did N/POP increase during the last 30 years? • What is expected for the future of N/POP? • How can US expect to raise average living standards in the future?

17. http://www.economist.com/markets/indicators/displaystory.cfm?story_id=8632028http://www.economist.com/markets/indicators/displaystory.cfm?story_id=8632028

18. Determinants of Average Labor Productivity • Human Capital • Physical Capital • Natural Resources • Technology • Entrepreneurship and Management • Political and Legal Environment

19. Human Capital • Human capital of workers includes the • Talents • Education • Training • Skills http://www.npr.org/player/v2/mediaPlayer.html?action=1&t=1&islist=false&id=172034480&m=172038811

20. Physical Capital • Quantity and quality of machines, tools, equipment and buildings affect the productivity of labor. • How productive is a computer programmer without a computer? • Using MB vs. MC principle to allocate machinery. • Diminishing returns reduces the MB for the next machine.

21. Natural Resources • Abundant land, energy, raw materials will allow inputs to be cheap for producing certain products, giving a country comparative advantage in these products. • Free trade practically frees a country from the yoke of lack of natural resources.

22. Technology • New technologies that increase the productivity of labor is commonplace in our age. • New ways of organizing, presenting, sequencing, etc. are also considered technological advances. • Technological improvements in one area may have positive spillover effects in another industry.

23. Entrepreneurship and Management • Entrepreneurs take risks to introduce new products, new processes into the economy. • Societies that provide secure property rights, low and predictable taxation and independent, incorruptible legal system support the flourishing of entrepreneurial activity. (See M. Olson, Power and Prosperity.)

24. Entrepreneurship and Management • China in the Middle Ages was far superior to the West technologically. However, the social system stifled economic growth: application of technology to production. • Management is every day operation of the establishment. Education is supposed to reduce the incidences of wrong decisions in everyday operations.

25. Political and Legal Environment • It is the function of the government to provide an environment where individuals and firms are not subjected to arbitrary rules, increasing the uncertainty of efforts. • Enforceable contracts, well-defined property rights, political and social environment conducive to taking risks in production are responsibilities of governments.

26. The Determinants of Average Labor Productivity • Economic Naturalist • Why did communism fail? • There was an absence of: • Private property rights. • Free markets. • Political stability. • Modern legal framework.

27. Worldwide Productivity Slowdown • Starting with 1973, industrialized nation experienced a significant productivity slowdown. • Slow growth brings social problems. • Redistribution can exacerbate these problems.

28. Average Labor Productivity Growth Rates in Selected Countries, 1960-2000 Percentage growth, annual rates Country 1960-1973 1973-1979 1979-2000 France 4.6 2.3 1.8 Germany 4.0 2.6 2.0 Japan 7.6 2.7 2.0 United Kingdom 2.8 1.3 1.7 United States 2.3 0.6 1.7

29. Why Did Productivity Slow Down? • Decline in public education? • Oil price shocks? • Poor measurement of productivity gains in service sector? • The exceptional experience of the 50s and 60s?

30. Costs of Economic Growth • Resources allocated to capital formation will reduce production of consumer goods. • Unsanitary, unsafe conditions for industrial workers (historical for US, current for many LDCs). • Is the sacrifice today, worth better living conditions tomorrow?

31. How to Increase Growth Rates? • The factors that determine average labor productivity may be enhanced by public policy.

32. Policies to Increase Human Capital • Education increases human capital. • Why does the government provide “free” K-12 education? • Positive externalities: Private demand does not capture all the societal benefits. • Who should decide the content of curriculum?

33. Policies to Promote Saving and Investment • Capital stock in a country increases through investment activities. • Investments require resources diverted from consumption goods to capital goods. • If consumers do not restrict their consumption (if they don’t save) total expenditures will exceed the value of production and inflation will ensue.

34. Policies to Promote Saving and Investment • High rates of saving allow a country to channel resources into capital formation. • Governments can pass laws to promote saving and laws to promote investment. • Governments also can create capital stock directly (how does it pay?)

35. Policies to Support R&D • Public good aspect of knowledge reduces private investment in knowledge. • Collective decision-making is required for activities with higher social benefits than individual benefits, e.g. basic research.

36. Legal and Political Framework • Political stability • Free and open exchange of ideas • Secure property rights • Well functioning legal system • Free markets (except for those with significant externalities)

37. Promoting Economic Growth • The Poorest Countries: A Special Case? • Improve the legal and political framework • Corrupt legal systems create uncertainty about property rights • Taxation and regulation discourages entrepreneurship • Markets are not allowed to function • Lack of political stability discourages foreign investment

38. The Economist, Dec 23, 2006

39. Promoting Economic Growth • The Poorest Countries: A Special Case? • Without political stability, foreign aid will not be effective.

40. Limits to Growth? • Will we run out of oil (natural resources)? • Market mechanisms: price incentives • Will we spoil the environment completely? • Change in tastes and preferences • Can we solve the global warming problem? • Limits to collective decision-making.

41. Are There Limits to Growth? • Limits to growth, assumes economic growth will take the form of what we have now.

42. Are There Limits to Growth? • Limits to growth, overlooks that growth expands society’s capacity to safeguard the environment. • Limits to growth, underestimates the power of markets to deal with scarcity.

43. A The Relationship between Air Pollution and Real GDP per Person Air pollution Real GDP per person

44. Commodity Prices FIRST published in 1864, with figures stretching back to 1845, The Economist's commodity-price index is probably the world's oldest regularly published price index. Since October 2001, our dollar-based industrials index has risen by 76%, fuelled by Chinese demand for raw materials and, in part, the weakness of the dollar. Yet in real terms, industrial commodity prices are a mere 30% of their value in 1845 http://www.economist.com/printedition/displayStory.cfm?Story_ID=3651836