© 2003 McGraw-Hill Ryerson Limited. Growth, Productivity, and the Wealth Of Nations Chapter 8.

© 2003 McGraw-Hill Ryerson Limited.

Growth, Growth, Productivity, and the Productivity, and the

Wealth Of NationsWealth Of Nations

Chapter 8Chapter 8

8 - 2


Laugher CurveLaugher Curve

We have two classes of forecasters:

Those who don't know, and those who don't know they don't know.

John Kenneth Galbraith

8 - 3


Growth and the Growth and the Economy’s PotentialEconomy’s Potential Growth is an increase in the amount of

goods and services an economy produces.

The study of growth is the study of why that increase comes about assuming that both labour and capital are fully employed.

8 - 4


Growth and the Growth and the Economy’s PotentialEconomy’s Potential Growth is an increase in potential

output. When an economy is at its potential

output, it is operating on its production possibility curve.

8 - 5


Growth and the Growth and the Economy’s PotentialEconomy’s Potential Long-run growth focuses on supply; it

assumes Say’s Law – demand is sufficient to buy whatever is supplied.

8 - 6


Growth and the Growth and the Economy’s PotentialEconomy’s Potential In the short run, economists consider

potential output fixed. They focus on how to get the economy

operating at its potential if, for some reason, it is not.

8 - 7


Importance of Growth Importance of Growth for Living Standardsfor Living Standards Growth is important for living standards. Long-term growth rates matter a lot

because of compounding. This means that growth is based not

only on original levels of income in a country, but also on the accumulation of previous years’ increases in income.

8 - 8


Importance of Growth Importance of Growth for Living Standardsfor Living Standards According to the rule of 72, dividing 72

by the rate of growth will give the number of years in which income will double.

8 - 9


Markets, Markets, Specialization, and Specialization, and GrowthGrowth Markets and specialization lead to

growth. Economic growth began when markets

developed (early 1800s), and as they expanded, growth accelerated.

8 - 10


Markets, Markets, Specialization, and Specialization, and GrowthGrowth Markets increase productivity through

specialization and the division of labour. Specialization – the concentration of

individuals on certain aspects of production

Division of labour – the splitting up of a task to allow for specialization of production.

Productivity – output per unit of input.

8 - 11


Markets, Markets, Specialization, and Specialization, and GrowthGrowth With increasing specialization and

division of labour comes increasing productivity which creates a higher standard of living.

8 - 12


Markets, Markets, Specialization, and Specialization, and GrowthGrowth This argument is reinforced by the

principle of comparative advantage. Production possibilities rise when people

concentrate on producing those goods for which their skills and other resources are suited, and trade for those goods for which they do not have a comparative advantage.

8 - 13


Economic Growth, Economic Growth, Distribution, and Distribution, and MarketsMarkets Markets are often seen to be unfair

because of the effect they may have on the distribution of income.

Markets may not provide equality of income but they do make the poor better off.

8 - 14


Economic Growth, Economic Growth, Distribution, and Distribution, and MarketsMarkets Would the poor be better off without

markets? Historically, judged from an absolute

standard, there is strong evidence that the poor benefit enormously from the growth that markets foster.

8 - 15


Economic Growth, Economic Growth, Distribution, and Distribution, and MarketsMarkets Judged from a relative standard, it is not

at all clear that markets require the large differentials in pay that has accompanied growth in market economies.

8 - 16


Per Capita GrowthPer Capita Growth

Per capita output is total output divided by total population.

Per capita growth means producing more goods and services per person.

8 - 17



Per capita growth equals the percent change in output minus the percent change in population

8 - 18



The problem in many developing nations is that although GDP is rising, the population is rising even faster resulting in a lower per capita growth rate.

8 - 19



Some economists have argued that per capita (mean) output is not what we should be focusing on.

Instead we should focus on median income.

8 - 20



Median income is a better measure because it takes into account how income is distributed.

8 - 21



If the growth in income goes to a small majority of individuals who receive the majority of income, the mean will rise but the median will not.

8 - 22



Unfortunately, statistics on median income is generally not collected so economists use per capita income.

8 - 23


The Sources of GrowthThe Sources of Growth

Economists identify five important sources of growth: Capital accumulation – investment in

productive capacity. Available resources. Growth-compatible institutions. Technological development. Entrepreneurship.

8 - 24


Investment and Investment and Accumulated CapitalAccumulated Capital Years ago it was thought that physical

capital and investment were the keys to growth.

The flow of investment lead to the growth of the stock of capital.

8 - 25


Investment and Investment and Accumulated CapitalAccumulated Capital Capital accumulation does not

necessarily lead to growth. Take the former Soviet Union, for

example. They invested a lot, but did not grow much.

8 - 26


Investment and Investment and Accumulated CapitalAccumulated Capital Products change, and useful buildings

and machines in one time period may be useless in another.

8 - 27


Investment and Investment and Accumulated CapitalAccumulated Capital Capital is much more than machines – it

includes human and social capital. Human capital – the skills that are

embodied in workers through experience, education, on-the-job training, and:

Social capital – the habitual way of doing things that guides people in how they approach production.

8 - 28


Investment and Investment and Accumulated CapitalAccumulated Capital All economists agree that the right kind

of investment at the right time is a central element of growth.

8 - 29


Available ResourcesAvailable Resources

For an economy to grow it will need resources.

What constitutes a resource at one time may not be a resource at another time.

8 - 30


Available ResourcesAvailable Resources

Technology plays an enormous role here.

Greater participation in the market is another way by which available resources are increased.

8 - 31


Growth Compatible Growth Compatible InstitutionsInstitutions Growth-compatible institutions have

built-in incentives that lead people to put forth effort and discourage loafing.

When individuals get much of the gains of growth themselves, they work harder.

8 - 32


Growth Compatible Growth Compatible InstitutionsInstitutions Markets that feature private ownership

of property foster economic growth. Mercantilist economies that feature

bribes inhibit economic growth.

8 - 33


Technological Technological DevelopmentDevelopment A larger aspect of growth involves

changes in technology – changes in the goods and services we buy, and the way we create goods and services.

8 - 34


Technological Technological DevelopmentDevelopment Technological change does more than

cause economic growth, it changes the entire social and political dimensions of society.

As in other things, there are tradeoffs when new technology is introduced.

8 - 35


EntrepreneurshipEntrepreneurship

Entrepreneurship is the ability to get things done.

That ability involves creativity, vision, and a talent for translating that vision into reality.

8 - 36


Turning the Sources of Turning the Sources of Growth into GrowthGrowth into Growth In order to be effective, the five sources

of growth must be mixed in the right proportions.

It is the combination of investing in machines, people, and technological change that plays a central role in the growth of any economy.

8 - 37


The Production The Production Function and Theories Function and Theories of Growthof Growth Economists’ theories of growth have

emphasized the production function. Production function –shows the

relationship between the quantity of inputs used in production and the quantity of output resulting from production.

8 - 38


The Production The Production Function and Theories Function and Theories of Growthof Growth This production function has land,

labour, and capital as factors of production, and an adjustment factor, “A”, to capture the effect of technology:

Output = A• f(Labour, Capital, Land)

8 - 39


The Production The Production Function and Theories Function and Theories of Growthof Growth In talking about production functions,

economists use a couple of terms: scale economies and diminishing marginal productivity.

8 - 40


The Production The Production Function and Theories Function and Theories of Growthof Growth Scale economies describe what happens

when all inputs increase equally.

Constant returns to scale means that output will rise by the same proportionate increase as all inputs.

8 - 41


The Production The Production Function and Theories Function and Theories of Growthof Growth Increasing returns to scale occur if

output rises by a greater proportionate increase than all inputs.

Decreasing returns to scale occur if output rises by a smaller proportionate increase than all inputs.

8 - 42


The Production The Production Function and Theories Function and Theories of Growthof Growth Diminishing marginal productivity

describes what happens when more of one input is added without increasing any other inputs.

8 - 43


The Production The Production Function and Theories Function and Theories of Growthof Growth The law of diminishing marginal

productivity states that increasing one input, keeping all others constant, will lead to smaller and smaller gains in output.

8 - 44


The Classical Growth The Classical Growth ModelModel The Classical growth model is the

standard theory of growth. The Classical growth model focuses on

capital accumulation.

8 - 45


The Classical Growth The Classical Growth ModelModel Since investment leads to the increase

in capital, Classical economists focused their analysis and their policy advice, on how to increase investment.

8 - 46


The Classical Growth The Classical Growth ModelModel The linkage was as follows:

savings investment increases in capital growth

8 - 47


Diminishing Marginal Diminishing Marginal Productivity of LabourProductivity of Labour The Classical growth model focuses on

diminishing marginal productivity of labour.

8 - 48


Diminishing Marginal Diminishing Marginal Productivity of LabourProductivity of Labour When farming was the major activity in

the economy, Thomas Malthus, an early economist, emphasized the limitation land placed on growth.

8 - 49


Diminishing Marginal Diminishing Marginal Productivity of LabourProductivity of Labour Since land was fixed, he predicted that

diminishing marginal productivity would set in as population grew.

8 - 50


Diminishing Marginal Diminishing Marginal Productivity of LaborProductivity of Labor The linkage was:

economic surplus population increases

output increases lower per capita

income too many people starvation

8 - 51


Diminishing Returns Diminishing Returns and Population Growth, and Population Growth, Fig. 8-2, p 197Fig. 8-2, p 197

Output

Labour

Subsistence level of output per worker

Production function

Q1

Q2

L1 L*

8 - 52


Diminishing Marginal Diminishing Marginal Productivity of LaborProductivity of Labor This belief is called the iron law of

wages Combined with diminished marginal

productivity it led to the belief that in the long run there would be no surplus and therefore no growth.

The long run was called the stationary state.

8 - 53


Diminishing Marginal Diminishing Marginal Productivity of CapitalProductivity of Capital The Classical economists’ predictions

were wrong. Increases in technology and capital

overwhelmed the law of diminishing marginal productivity.

The focus turned to the marginal productivity of capital, not labour.

8 - 54


Diminishing Marginal Diminishing Marginal Productivity of CapitalProductivity of Capital The linkage was:

capital grows faster than labour capital is less productive slower economic

output per capita growth stagnates per capita income stops rising

8 - 55


Diminishing Marginal Diminishing Marginal Productivity of CapitalProductivity of Capital The Classical growth model also

predicted that diminishing marginal productivity would be stronger for richer nations than for poorer ones.

8 - 56


Diminishing Marginal Diminishing Marginal Productivity of CapitalProductivity of Capital Poor countries with little capital should

grow faster than countries with lots of capital.

Eventually per capita incomes among nations would converge.

8 - 57


Diminishing Marginal Diminishing Marginal Productivity of CapitalProductivity of Capital This prediction was not true either,

owing to the ambiguity in the definition of inputs and/or technological progress.

8 - 58


Ambiguities in the Ambiguities in the Definition of the Definition of the Factors of ProductionFactors of Production The definition of the factors of

production are ambiguous. It would seem that the definition of

labour would be straightforward – the hours of work that go into production.

8 - 59


Ambiguities in the Ambiguities in the Definition of the Definition of the Factors of ProductionFactors of Production But what of the difference between

educated workers and workers who are less educated?

To answer this, economists separate labour into two components.

8 - 60


Ambiguities in the Ambiguities in the Definition of the Definition of the Factors of ProductionFactors of Production Standard labour – the actual number

of hours worked. Human capital – the skills embedded in

workers through experience, education, and on-the-job training.

8 - 61


Ambiguities in the Ambiguities in the Definition of the Definition of the Factors of ProductionFactors of Production Increases in human capital have

allowed labour to keep pace with capital.

This allows economies to avoid the diminishing productivity of capital.

8 - 62


Ambiguities in the Ambiguities in the Definition of the Definition of the Factors of ProductionFactors of Production If skills are increasing faster in a rich

country than in a poor one, incomes would not converge.

8 - 63


TechnologyTechnology

Technology overwhelms diminishing marginal productivity so that growth rates can increase over time.

Technology is growing faster in rich countries than in poor countries.

8 - 64


Sources of Real GDP Sources of Real GDP Growth, 1928-1998, Growth, 1928-1998, Fig. 8-Fig. 8-

3, p 1993, p 199

Human capital (13%)Physical capital (19%)

Technology (35%)Labor (33%)

8 - 65


New Growth TheoryNew Growth Theory

New growth theory emphasizes the role of technology rather than capital in the growth process.

8 - 66



Technology is the result of investment in creating technology (research and development).

Investment in technology increases the technological stock of an economy.

8 - 67



Growth theory separates investment in capital and investment in technology.

Increases in technology are not as directly linked to investment as is capital.

8 - 68



Increases in technology often have enormous positive spillover effects.

Technological advances in one sector of the economy lead to advances in completely different sectors.

8 - 69



Technological advances have positive externalities – positive effects on others not taken into account by the decision maker.

8 - 70



Some basic research is protected by patents – legal ownership of a technological innovation that gives the owner of the patent sole rights to its use and distribution for a limited time.

8 - 71



Once people have seen the new technology, they figure out sufficiently different ways to achieving the same end to avoid the patent.

8 - 72


Learning by DoingLearning by Doing

Learning by doing also leads to growth. New growth theory also highlights

learning by doing – improving the methods of production through experience.

8 - 73


Learning by DoingLearning by Doing

If positive externalities flowing from learning by doing and new technologies overwhelm diminishing marginal productivity, economics can be called the “optimistic science,” not the “dismal science.”

8 - 74


Increasing Returns to Increasing Returns to Scale, Scale, Fig. 8-4, p 201Fig. 8-4, p 201

Output

All inputs

Production function with increasing returns

8 - 75


Technological Lock-InTechnological Lock-In

Technological lock-in is an example of how sometimes the economy does not use the best technology available.

8 - 76



Technological lock-in occurs when old technologies become entrenched in the market, or locked into new products despite the fact that more efficient technologies are available. The best example is the QWERTY

keyboard.

8 - 77



One reason for technological lock-in is network externalities.

Network externalities – an externality in which the use of a good by one individual makes that technology more valuable to other people.

8 - 78



Switching from a technology exhibiting network externalities to a superior technology is expensive and sometimes nearly impossible. The Windows operating system

exhibits network externalities.

8 - 79


Economic Policies to Economic Policies to Encourage Per Capita Encourage Per Capita GrowthGrowth Policies to encourage saving and

investment. Policies to control population growth. Policies to increase the level of

education.

8 - 80


Economic Policies to Economic Policies to Encourage Per Capita Encourage Per Capita GrowthGrowth Policies to increase the level of

education Policies to create institutions that

encourage technological innovation. Policies to provide funding for basic

research. Policies to increase the economy’s

openness to trade.

8 - 81


Policies to Encourage Policies to Encourage Saving and InvestmentSaving and Investment Modern growth theories have

downplayed the importance of capital in the growth process. All agree that it is important,

however. Policy makers are eager to encourage

both saving and investment.

8 - 82


Policies to Encourage Policies to Encourage Saving and InvestmentSaving and Investment Canada has used tax incentives to

increase saving. These include retirement savings plans

(RSPs) that allow individuals to save without incurring taxes on contributions until they are withdrawn.

8 - 83


Policies to Encourage Policies to Encourage Saving and InvestmentSaving and Investment Some economists have proposed

switching from an income tax to a consumption tax.

By taxing individuals only when they consume, all saving is exempt from taxation.

8 - 84


Policies to Encourage Policies to Encourage Saving and InvestmentSaving and Investment It is difficult for poor countries to

generate saving and investment. The poor have subsistence income

while the rich in those countries place their savings abroad for fear of confiscation by government.

8 - 85


The Borrowing CircleThe Borrowing Circle

The borrowing circle of Grameen bank is an example of how to increase investment in a developing nation. The traditional way of lending money

is to ask for collateral. In Bangladesh, potential borrowers

had no collateral.

8 - 86


The Borrowing CircleThe Borrowing Circle

The bank officer replaced collateral with the borrowing circle concept. Borrowing circle concept – a credit

system that replaces traditional collateral with guarantees by friends of the borrower.

In case of a default, the friends had to make the loan good.

8 - 87


Growth Through Growth Through Foreign InvestmentForeign Investment Foreign investment provides another

source of saving. Developing nations can borrow from

the IMF, the World Bank, or from private sources.

None of these are perfect solutions since they come with large strings attached.

8 - 88


Policies to Control Policies to Control Population GrowthPopulation Growth Developing nations whose populations

are rapidly growing have difficulty providing enough capital and education for everyone.

Thus, per capita income is low.

8 - 89


Policies to Control Policies to Control Population GrowthPopulation Growth Policies that reduce population growth

include: Free family–planning services. Increasing the availability of

contraceptives. Harsh mandatory one-child-per-family

policies such as China adopted in 1980.

8 - 90


Policies to Control Policies to Control Population GrowthPopulation Growth Some economists argue that to reduce

population growth, a nation must grow first. As income and work opportunities,

especially for women, rise, the opportunity cost of having children rises and families will choose to have fewer children.

8 - 91


Policies to Increase the Policies to Increase the Level of EducationLevel of Education In developing nations, the return on

investments in education is much higher than in developed nations.

8 - 92


Policies to Increase the Policies to Increase the Level of EducationLevel of Education In Canada, it is estimated that an

additional year of school increases a worker’s wages by an average of 10 percent.

An additional year of school in developing nations will increase income by 15-20 percent.

8 - 93


Policies to Increase the Policies to Increase the Level of EducationLevel of Education Technical training in improved farming

methods or construction is more important than higher education.

8 - 94


Policies to Create Policies to Create Institutions That Institutions That Encourage Encourage Technological Technological InnovationInnovation While all agree that that technology is

important, no one is sure what the best technological growth policies are.

Not only is research uncertain, so is its application.

8 - 95


Create Patents and Create Patents and Protect Property RightsProtect Property Rights Creating patents and protecting

property rights are two ways to encourage innovation.

However: Patents are not costless to society. Patents allow innovators to charge

high prices for their use.

8 - 96


Patents and Developing Patents and Developing CountriesCountries Should poor nations accept patent

laws? Societies must find a middle ground

between giving individuals appropriate incentives to create new technologies and allowing everyone to take advantage of the benefits of technology.

8 - 97


The Corporation and The Corporation and Financial InstitutionsFinancial Institutions The corporation and financial

institutions encourage innovation.

8 - 98


The Corporation and The Corporation and Financial InstitutionsFinancial Institutions The corporation was invented to limit

liability to its owners. Corporations bring technological

innovations to markets.

8 - 99


The Corporation and The Corporation and Financial InstitutionsFinancial Institutions Well-developed financial institutions

such as stock markets create liquidity and encourage investment.

8 - 100


Policies to Provide Policies to Provide Funding for Basic Funding for Basic ResearchResearch Individual firms have little incentive to

do basic research because of technology’s “common knowledge” aspect.

This is where the government steps in.

8 - 101


Policies to Provide Policies to Provide Funding for Basic Funding for Basic ResearchResearch The Canadian government provides the

lion’s share of the basic research in the country.

Much of the funding is channeled through universities.

8 - 102


Policies to Increase Policies to Increase Openness to TradeOpenness to Trade In order to specialize, you need a large

market. Large markets allow firms to take

advantage of economies of scale.

8 - 103


Policies to Increase Policies to Increase Openness to TradeOpenness to Trade The effect of markets on growth is an

important reason why economists support policies that keep domestic markets as regulation free as possible and support international trade.


Growth, Growth, Productivity, and the Productivity, and the

Wealth Of NationsWealth Of Nations

End of Chapter 8End of Chapter 8

Date post:	22-Dec-2015
Category:	Documents
Upload:	morgan-daniels
View:	217 times
Download:	1 times

© 2003 McGraw-Hill Ryerson Limited. Growth, Productivity, and the Wealth Of Nations Chapter 8.

Documents