Economic Growth, Productivity, and Living Standards

1. Economic Growth, Productivity, and Living Standards

2. Introduction • “Which would you rather be? An ordinary, middleclass American living today, or the richest person in America at the time of George Washington?” Chapter 7: Economic Growth, Productivity, and Living Standards

3. Real GDP per Person In Selected Countries, 1870-2003 (in 2000 U.S. Dollars) Annual % change 1870-2003 Annual % change 1950-2003 Country 1870 1913 1950 1979 2003 Australia 5,512 7,236 9,369 17,670 28,312 1.2 2.1 Canada 2,328 5,509 8,906 19,882 29,201 1.9 2.3 France 2,291 4,484 6,164 18,138 26,176 1.8 2.8 Germany 1,152 2,218 4,785 17,222 25,271 2.3 3.2 Italy 2,852 4,018 5,128 16,912 25,458 1.7 3.1 Japan 931 1,763 2,141 16,329 26,636 2.6 4.9 United Kingdom 3,892 5,976 8,709 16,557 26,852 1.5 2.1 United States 2,887 6,852 12,110 22,835 35,488 1.9 2.0 Chapter 7: Economic Growth, Productivity, and Living Standards

4. Real GDP per Person in Five Industrialized Countries, 1870 - 2003 Chapter 7: Economic Growth, Productivity, and Living Standards

5. The Remarkable Rise in Living Standards: The Record • A Caveat • Historical estimates are less precise • Comparing economic output over a century cannot account for new goods and services Chapter 7: Economic Growth, Productivity, and Living Standards

6. The Remarkable Rise in Living Standards: The Record • Observation • The variety, quality, and quantity of goods and services increased enormously during the 19th and 20th centuries, as reflected in real per capita GDP. Chapter 7: Economic Growth, Productivity, and Living Standards

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 Chapter 7: Economic Growth, Productivity, and Living Standards

8. Real GDP per Person In Selected Countries, 1870-2003 (in 2000 U.S. Dollars) Annual % change 1870-2003 Annual % change 1950-2003 Country 1870 1913 1950 1979 2003 Australia 5,512 7,236 9,369 17,670 28,312 1.2 2.1 Canada 2,328 5,509 8,906 19,882 29,201 1.9 2.3 France 2,291 4,484 6,164 18,138 26,176 1.8 2.8 Germany 1,152 2,218 4,785 17,222 25,271 2.3 3.2 Italy 2,852 4,018 5,128 16,912 25,458 1.7 3.1 Japan 931 1,763 2,141 16,329 26,636 2.6 4.9 United Kingdom 3,892 5,976 8,709 16,557 26,852 1.5 2.1 United States 2,887 6,852 12,110 22,835 35,488 1.9 2.0 • Observations • 2000 Real Per Capital GDP in Japan was greater than Australia • 2003 Australia’s Real Per Capita GDP was greater than Japan • Small changes in growth rates make a big difference Chapter 7: Economic Growth, Productivity, and Living Standards

9. Why “Small” Differences in Growth Rates Matter • Compound Interest • Suppose: • In 1800 $10 deposited @ 4% interest • In 2005 the account is worth $25,507.50 • $10 x (1.04)205 = $31,033.77 Chapter 7: Economic Growth, Productivity, and Living Standards

10. Why “Small” Differences in Growth Rates Matter • Compound Interest • The payment of interest not only on the original deposit but on all previously accumulated interest Chapter 7: Economic Growth, Productivity, and Living Standards

11. Why “Small” Differences in Growth Rates Matter Interest rate (%) Value of $10 after 205 years 2 $579.48 4 $31,033.77 6 $1,540,644.29 • Observations • A small sum compounded over long periods can greatly increase in value • Small differences in interest have a very large impact on value Chapter 7: Economic Growth, Productivity, and Living Standards

12. Why “Small” Differences in Growth Rates Matter • Compound Interest • Economic growth rates are similar to compound interest rates. • Government policies that affect the long-term growth rate by a small amount will have a major economic impact. Chapter 7: Economic Growth, Productivity, and Living Standards

13. Why “Small” Differences in Growth Rates Matter • Economic Naturalist • China as Number One? • What kept Japan from becoming number one? • Will China become number one? Chapter 7: Economic Growth, Productivity, and Living Standards

14. China’s Share of World Populationand Consumption, 2002-2003 Population (%) 20.5 Consumption of (%) Pork 51 Cigarettes 35 Cotton 33 Fish 32 Steel 27 Televisions 23 Ice Cream 19 Washing machines 18 Computers 6 Soda 4 Chapter 7: Economic Growth, Productivity, and Living Standards

15. Why Nations Become Rich: The Crucial Role of Average Labor Productivity • Question • What determines a nation’s economic growth rate? • Some definitions: • Y = real GDP • N = number of employed workers • POP = total population Chapter 7: Economic Growth, Productivity, and Living Standards

16. Why Nations Become Rich: The Crucial Role of Average Labor Productivity • Real GDP Per Person Chapter 7: Economic Growth, Productivity, and Living Standards

17. Why Nations Become Rich: The Crucial Role of Average Labor Productivity • Real GDP Per Person • Observations • Real output/person depends on: • How much each worker can produce. • The percent of the population that is working. Chapter 7: Economic Growth, Productivity, and Living Standards

18. Real GDP per Person and Average Labor Productivity in the U.S., 1960 - 2004 Chapter 7: Economic Growth, Productivity, and Living Standards

19. Share of the U.S. Population Employed, 1960 - 2004 Chapter 7: Economic Growth, Productivity, and Living Standards

20. Why Nations Become Rich: The Crucial Role of Average Labor Productivity • Question • What determines a nation’s economic growth rate? • In the long run, increases in output per person arise primarily from increases in average labor productivity. Chapter 7: Economic Growth, Productivity, and Living Standards

21. The Determinants of Average Labor Productivity • Human Capital • The talents, education, training, and skills of workers Chapter 7: Economic Growth, Productivity, and Living Standards

22. The Determinants of Average Labor Productivity • Example • Lucy and Ethel on the assembly line • Lucy and Ethel wrap and box chocolate candies. • Lucy (a novice) wraps 100 candies/hr or 4,000/week • Ethel (received on-the-job training) wraps 300/hr or 12,000/week • Average labor productivity/week = 16,000/2 = 8,000/week or 16,000/80 hrs = 200 candies/hr • Ethel (with training) is more productive than Lucy Chapter 7: Economic Growth, Productivity, and Living Standards

23. The Determinants of Average Labor Productivity • Physical Capital • Worker productivity depends not only on their skills (human capital) but on the tools (physical capital) they have to work with. Chapter 7: Economic Growth, Productivity, and Living Standards

24. The Determinants of Average Labor Productivity • Example • Lucy and Ethel get automated • Candy Co buys a candy-wrapping machine operated by one worker • An untrained worker using the machine can wrap 500 candies/hr • Lucy uses the machine and Ethel wraps by hand Chapter 7: Economic Growth, Productivity, and Living Standards

25. The Determinants of Average Labor Productivity • Example • Lucy and Ethel get automated • Lucy’s weekly output (40 hrs x 500) = 20,000 candies • Ethel’s weekly output (40 hrs x 300) = 12,000 candies • Total output = 32,000 candies/week or average labor productivity = 16,000 candies/week or 32,000/80 hrs. = 400 candies/hr. • Double the average productivity without the machine Chapter 7: Economic Growth, Productivity, and Living Standards

26. Capital, Output, and Productivity in the Candy-Wrapping Factory (1) Number of machines (capital) (2) Total number of candies wrapped each week (output) (3) Total hours worked per week (4) Candies wrapped per hour worked (productivity) 0 16,000 80 200 1 32,000 80 400 2 40,000 80 500 3 40,000 80 500 • Observations • For a given number of workers, adding capital will generally increase output and average labor productivity • The more capital that is already in place, the smaller the benefits of adding extra capital Chapter 7: Economic Growth, Productivity, and Living Standards

27. The Determinants of Average Labor Productivity • Diminishing Returns to Capital • If the amount of labor and other inputs employed is held constant, then the greater the amount of capital already in use, the less an additional unit of capital adds to production. Chapter 7: Economic Growth, Productivity, and Living Standards

28. The Determinants of Average Labor Productivity • Physical Capital • Public policy designed to stimulate growth should consider that: • Increasing the amount of capital available to the workforce will tend to increase output and average labor productivity. • The degree to which productivity can be increased by an expanding stock of capital is limited. Chapter 7: Economic Growth, Productivity, and Living Standards

29. Average Labor Productivity and Capital per Worker in 15 Countries, 1990 Chapter 7: Economic Growth, Productivity, and Living Standards

30. The Determinants of Average Labor Productivity • Land and Other Natural Resources • Generally, an abundance of natural resources increases the productivity of workers. • Resources can be obtained through international markets. Chapter 7: Economic Growth, Productivity, and Living Standards

31. The Determinants of Average Labor Productivity • Technology • New technologies are the single most important source of productivity improvement. • A new technology will expand the productivity in many sectors by stimulating greater specialization. Chapter 7: Economic Growth, Productivity, and Living Standards

32. The Determinants of Average Labor Productivity • Economic Naturalist • Why has U.S. labor productivity grown so rapidly since 1995? Chapter 7: Economic Growth, Productivity, and Living Standards

33. The Determinants of Average Labor Productivity • Entrepreneurship and Management • Entrepreneurs • People who create new economic enterprises Chapter 7: Economic Growth, Productivity, and Living Standards

34. The Determinants of Average Labor Productivity • Entrepreneurship and Management • Factors influencing entrepreneurship • Taxation • Regulation • Social Customs Chapter 7: Economic Growth, Productivity, and Living Standards

35. The Determinants of Average Labor Productivity • Entrepreneurship and Management • Management: • Influence productivity by implementing more efficient methods of production. Chapter 7: Economic Growth, Productivity, and Living Standards

36. The Determinants of Average Labor Productivity • Economic Naturalist • Why did medieval China stagnate economically? Chapter 7: Economic Growth, Productivity, and Living Standards

37. The Determinants of Average Labor Productivity • The Political and Legal Environment • Establish: • Well-defined property rights • Maintain political stability • Promote free and open exchange of ideas Chapter 7: Economic Growth, Productivity, and Living Standards

38. The Determinants of Average Labor Productivity • Economic Naturalist • Why did communism fail? • Output per person in the Soviet Union was probably less than one-seventh the U.S. rate. • The Soviet Union had: • Human capital. • Physical capital. • Natural resources. • Technology. Chapter 7: Economic Growth, Productivity, and Living Standards

39. 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. Chapter 7: Economic Growth, Productivity, and Living Standards

40. The Costs ofEconomic Growth • Costs of Economic Growth • The opportunity cost of increasing the production of capital goods is: • Less consumer goods. • Reduced leisure time, worker’s safety, and health. • The cost of R & D. • The cost of education (human capital). Chapter 7: Economic Growth, Productivity, and Living Standards

41. The Costs ofEconomic Growth • What Do You Think? • Do the benefits of economic growth exceed the costs? Chapter 7: Economic Growth, Productivity, and Living Standards

42. Promoting Economic Growth • Economic Naturalist • Why do almost all countries provide free public education? Chapter 7: Economic Growth, Productivity, and Living Standards

43. Promoting Economic Growth • Promoting Growth • Policies that promote saving and investment • Policies that support research and development • The legal and political framework Chapter 7: Economic Growth, Productivity, and Living Standards

44. 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 Chapter 7: Economic Growth, Productivity, and Living Standards

45. Promoting Economic Growth • The Poorest Countries: A Special Case? • Without political stability, foreign aid will not be effective. Chapter 7: Economic Growth, Productivity, and Living Standards

46. Are There Limits to Growth? • Limits to growth, assumes economic growth will take the form of what we have now. • 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. Chapter 7: Economic Growth, Productivity, and Living Standards

47. Are There Limits to Growth? • What Do You Think? • How can we address global environmental issues? Chapter 7: Economic Growth, Productivity, and Living Standards

48. Are There Limits to Growth? • Economic Naturalist • Why is the air quality so poor in Mexico City? Chapter 7: Economic Growth, Productivity, and Living Standards

49. A The Relationship between Air Pollution and Real GDP per Person Air pollution Real GDP per person Chapter 7: Economic Growth, Productivity, and Living Standards

50. End of Chapter