Frank & BernankeFrank & Bernanke

Ch. 8: Economic Growth, Productivity, and Living Standards

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

Source: http://hdr.undp.org/reports/global/2002/en/indicator/indicator.cfm?File=indic_290_1_1.html

http://hdr.undp.org/statistics/highlights/

Compound InterestCompound InterestSuppose 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

Compound InterestCompound Interest1% 2% 4% 8% 10%

Beginning Balance 100.00 100.00 100.00 100.00 100.00After one year 101.00 102.00 104.00 108.00 110.00After ten years 110.46 121.90 148.02 215.89 259.37After 30 years 134.78 181.14 324.34 1,006.27 1,744.94After 50 years 164.46 269.16 710.67 4,690.16 11,739.09

Impact on Living StandardsImpact 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.

Real GDP per CapitaReal GDP per CapitaReal 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.

Growth Rate of Y/POPGrowth Rate of Y/POPPercentage 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.

0

10000

20000

30000

40000

50000

60000

70000

1945 1955 1965 1975 1985 1995 2005

GDP/cap AvLabProd

N/POP

0.000

0.100

0.200

0.300

0.400

0.500

0.600

1945 1955 1965 1975 1985 1995 2005

US Experience and ForecastUS 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?

Determinants of Average Labor Determinants of Average Labor ProductivityProductivity

Human CapitalPhysical CapitalNatural ResourcesTechnologyEntrepreneurship and ManagementPolitical and Legal Environment

Human CapitalHuman Capital

Human capital of workers includes the– Talents– Education– Training– Skills

Physical CapitalPhysical CapitalQuantity 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.

Natural ResourcesNatural 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.

TechnologyTechnologyNew 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.

Entrepreneurship and Entrepreneurship and ManagementManagement

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.)

Entrepreneurship and Entrepreneurship and ManagementManagement

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.

Political and Legal Political and Legal EnvironmentEnvironment

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.

Soviet example.

Worldwide Productivity Worldwide Productivity SlowdownSlowdown

Starting with 1973, industrialized nation experienced a significant productivity slowdown.

Slow growth brings social problems.Redistribution can exacerbate these

problems.

Why Did Productivity Slow Why Did Productivity Slow Down?Down?

Decline in public education?Oil price shocks?Poor measurement of productivity gains in

service sector?The exceptional experience of the 50s and

60s?

Costs of Economic GrowthCosts 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?

How to Increase Growth How to Increase Growth Rates?Rates?

The factors that determine average labor productivity may be enhanced by public policy.

Policies to Increase Human Policies to Increase Human CapitalCapital

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?

Policies to Promote Saving Policies to Promote Saving and Investmentand 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.

Policies to Promote Saving Policies to Promote Saving and Investmentand 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?)

Policies to Support R&DPolicies 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.

Legal and Political FrameworkLegal and Political Framework

Political stabilityFree and open exchange of ideasSecure property rightsWell functioning legal systemFree markets (except for those with

significant externalities)

Limits to Growth?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.

Commodity PricesCommodity PricesFIRST 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

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