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168 cHAprER 5 . Long-Run Economic Growth LearmisusSfu$ett$we Explain the bafanced growthpath, convergence, and long-run equilibrium. Balanced growth n situation in which the capital-labor ratio anC real CDP perhour worked growat the same rate The Financial System The role of the financial system is to help the economy allocar resources by matching borrowen with lenders. When the financial systemworks well, ind- viduals who want to borrow to finance the accumulation of physical or human capital car: find lenders. To theextent that firms and the government payfor R&D with funds obtaino: through the financial system, a well-functioning financial qrstem can also lead to more investment in R&D. The financial system can also affect total factor productivity br improving the efficiency of the economy. The financial systemallocatesfunds to the ind:- viduals and firms who are willing to pay the most to obtain the funds. Theseindividud. and firms are also those whose investment projects have the best likelihood of succesi Therefore, a good financial system ensures that resources flow to their most productirt uses, and total factor productivity for the economy increases. As a consequence, labor pia- duaiviry and the standardof living are higher. Research by Thorsten Beck of the World Bank, Ross Levine of the University of Mirrnesota,and Norman Loayza of the Central Bank of Chile has shown that the finan- cial system has a significant effecton total factor productivity growth.raInterestingly, it is not just bank that matter for econonic growth. Ross Levine and Sara Zervos of the Worl,j Bank havefound that stock market liquidity alsoaffects productivity and capital accumu- lation.t5 The more liquid a stock market, the easier it is for investors to sell stock. Investorsare more likely to purchase stocks that they know are easyto sell.As a conse- quence, stock prices are higher,and it is less costly for firms to issuenew stock to pay for investmeritprojects. This research tells us that the developmentof financial marketsplars an important role in sustaining economic grorvth in both developed and developins economies. The Balanced Growth Path, Convergence, and Long-Run Equifibrium The steady stateis the equilibrium for the economy;however, it is an equilibrium in rvhich the key economic quantitiessuch asthe capital-labor ratio and real GDP per hour workeci are growing. Balanced growth occurs when the capital-labor ratio and real GDP per hour worked grow at the samerate. The bahncedgrowth paflr shows how real GDP per hour worked groil's over time r+'hen the economyis in the stefv-shte and experiencing balanceC gro*'th.,lVe can thin-li of the balanced growth path a{the equilibrium time path for real GDP per hour r+'orked. We can alsothink of each steadN stateashaving its own unique bal- anced grorrth path. Understanding the equilibrium time path is critical for understandine the long-run behavior of real GDP per hour worked and real GDP. i. i,ii",ai{i:nie tr ii'i; li*ianced {tr*vytb Fath Figure 5.i on page I45 showsthat the gror4h ratesfor most countries havebeen roughlv constantsince 1820, rvhich suggests that most of thesecountries havetypically beenon or near their balanced growth paths. ]ust asthe steady state is the equilibrium for the economv at a point ia tir:re, the balanced growth path is the equilibrium for the economyorcr time. Horvever, some countries, such as |apan, appear to have been off their balanced growth paths for extended periods of time. The experiences of Germanyand fapan after World War II provide a good example oi how an economythat is off its balanced growth path eventually converges back to that path. By the end of 'v\torld War II, both Germany and fapan had experienced large decreases in Ialhorsten tseck, Ros Levine, and Norman Loayza, "Ijinance and the Sources of Growthl'Journal of Financial Econorrics, \iol. 58,No. l-2, October-November 2000, pp. 261-300. r5Ross l*vine and Sara T.ervos, "Stock Markets, Banks, and Economic Grcwthl' Americnn Fronomic Reyiaw, Vol. 88, No. 3, )une 1998, pp. 537-558.
Transcript
  • 168 cHAprER 5 . Long-Run Economic Growth

    Learmisus Sfu$ett$weExplain the bafancedgrowth path,convergence, andlong-run equi l ibr ium.Balanced growth nsituation in which thecapital-labor ratio anCreal CDP per hour workedgrow at the same rate

    The Financial System The role of the financial system is to help the economy allocarresources by matching borrowen with lenders. When the financial system works well, ind-viduals who want to borrow to finance the accumulation of physical or human capital car:find lenders. To theextent that firms and the government payfor R&D with funds obtaino:through the financial system, a well-functioning financial qrstem can also lead to moreinvestment in R&D. The financial system can also affect total factor productivity brimproving the efficiency of the economy. The financial system allocates funds to the ind:-viduals and firms who are willing to pay the most to obtain the funds. These individud.and firms are also those whose investment projects have the best likelihood of succesiTherefore, a good financial system ensures that resources flow to their most productirtuses, and total factor productivity for the economy increases. As a consequence, labor pia-duaiviry and the standard of living are higher.

    Research by Thorsten Beck of the World Bank, Ross Levine of the University ofMirrnesota, and Norman Loayza of the Central Bank of Chile has shown that the finan-cial system has a significant effect on total factor productivity growth.ra Interestingly, it isnot just bank that matter for econonic growth. Ross Levine and Sara Zervos of the Worl,jBank have found that stock market liquidity also affects productivity and capital accumu-lation.t5 The more liquid a stock market, the easier it is for investors to sell stock.Investors are more likely to purchase stocks that they know are easy to sell. As a conse-quence, stock prices are higher, and it is less costly for firms to issue new stock to pay forinvestmerit projects. This research tells us that the development of financial markets plarsan important role in sustaining economic grorvth in both developed and developinseconomies.

    The Balanced Growth Path, Convergence, andLong-Run EquifibriumThe steady state is the equilibrium for the economy; however, it is an equilibrium in rvhichthe key economic quantities such as the capital-labor ratio and real GDP per hour workeciare growing. Balanced growth occurs when the capital-labor ratio and real GDP per hourworked grow at the same rate. The bahnced growth paflr shows how real GDP per hourworked groil's over time r+'hen the economy is in the stefv-shte and experiencing balanceCgro*'th.,lVe can thin-li of the balanced growth path a{the equilibrium time path for realGDP per hour r+'orked. We can also think of each steadN state as having its own unique bal-anced grorrth path. Understanding the equilibrium time path is critical for understandinethe long-run behavior of real GDP per hour worked and real GDP.

    i. i, i i",ai{i:nie tr i i ' i ; l i* ianced {tr*vytb FathFigure 5.i on page I45 shows that the gror4h rates for most countries have been roughlvconstant since 1820, rvhich suggests that most of these countries have typically been on ornear their balanced growth paths. ]ust as the steady state is the equilibrium for the economvat a point ia tir:re, the balanced growth path is the equilibrium for the economy orcr time.Horvever, some countries, such as |apan, appear to have been off their balanced growthpaths for extended periods of time.

    The experiences of Germany and fapan after World War II provide a good example oihow an economy that is off its balanced growth path eventually converges back to that path.By the end of 'v\torld War II, both Germany and fapan had experienced large decreases in

    Ialhorsten tseck, Ros Levine, and Norman Loayza, "Ijinance and the Sources of Growthl' Journal ofFinancial Econorrics, \iol. 58, No. l-2, October-November 2000, pp. 261-300.r5Ross l*vine and Sara T.ervos, "Stock Markets, Banks, and Economic Grcwthl' Americnn FronomicReyiaw, Vol. 88, No. 3, )une 1998, pp. 537-558.

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    The Balanced Growth Path, Convergence, and Long-Run Equilibrium 769

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    1820 1840 1860 1BB0 1900 1 920 1940 1 960 1 980 2000

    ,h.i1. .upitul-labor ratios as the United States and its allies bombed the factories, bridges':nd transportation networks in both countries. Figure 5.14 shows real GDP per capita 9ve1::rne tbr both Germany and ]apan. Both countries experienced a large decrease in real GDP

    -r capita at the end oiWorldWar II, due to the destruction of their capital stodi' However'

    ,i.., th. war, both countries grew much more rapidly than they did before the war.3ermany grew rapidly from ttre end of the war until about 1960' After 1960, Germany;npears io hut grown at the same rate as it did prior to the war. In fact, Germanv apPears:.-,iar,* been on th. ru*. growth path since 1960 that it u'as on before World War II' japan

    -d a similar experience. ih. .ountry grew rapidly from the end o{thewar until the mid-

    - i-Us when it appears to have moved to a higher balanced growth path compared to the

    rme :i rcas On 6ei6re ille War- illeru&r.., rflr"t4ntv"-stgauf'*ert'ea4nital-lahn'^atin-anrlornl GDP per hour worked must have increased'

    Why do countries return to the balanced growth path? We :*::t the Solorv growth

    -nrlel and the experiences of Germany and Japan toi*pl"in rvhy. Figure 5.15 shows for

    ffi

    krgas

    The Solow GrowthModel and Post-WorldWar ll Convergence inGerrnanyThe destruction of Germant/scapital stock at the end of lYorldWar II caused the caPital-laborratio to decrease frotn [* tokrgn:

    '

    and real GDP Per hourwprked to decrease frorn t' trt/tg+s. At that point, GermanYrvas belorv its balanced grorvthpatir. Postrtar GermanY exPgli-enced verv fast Srowth rates ofreal GDP as the country raPidlYaccumrilated caPital goods whileaPProadring its balanced growthpath. s

    Post-World War IlConvergence inGermany and JaPanGermany and |apan exPerienceda large decrease in real GDI' Percapita at the end of World lvVar IIdue to destruction of their caPitaistoclc Germary grerr raPidlYirom the end of the war untilabout 1960. After 1960,German,vaPPears to have grolfn at thesane rate as it did Prior tothe rvat. Japan grew raPidlY fromthe end of the \'Var until themid-1970s, but it aPPears to hi*tmoved to a higher balancedgrowth path comPared to the oneit rvas on before the wirr.

    Sourcc': lbtal Frotroinv Datirba se,The Confercnce Board: httP://wryw.conference-bo ard.orgldatalecono;nrdatabase/. s

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    Capital-labor ratio, k1 . The,capitalllaboi ratiodecreases af the end

    (d+ n)kre4s l. '-

  • 17$ cHAPTER 5 r Long-Run Economic Crowth

    Germany the effect of the destruction of tlre capital on real GDP per hour rvorked- German'istarted off in the steady state prior to world war II, with a capital labor ratio, ft* : ft rs:e,and real GDP per hour worked, f = ygts. Because the country was in the steady state, itwas also on the balanced growth path, so according to Table 5.3 on page 163, thecapital-labor ratio and real GDP per hour worked both grew at a rare of I.5ga. By the endof the war, Iarge portions of Germanyl capital stock had been destoyed. As a result, thecapital-labor ratio decreased from ts to ft1e45, and real GDP per hour rvorked decreasedkam f to "/rg+s. The decrease in labor productivity caused the decrease in real GDP percapita at the end of \&brld War iI that we see in Figure 5.14. After the war had ended, totalfactor productivity continued to grow, which caused real GDP per hour worked and realGDP per capita to grow. Horvever, because the capital-labor ratio had fallen to k1ea5, theGerman economy grew for an additional reason: It accumulated capital more quidily thaiit had along the balanced grorvth path.

    At &19a5, the level of investment, slrgqs, was greater than the break-even level oiinvestment, (d * n)k19a5, so the capital-labor ratio increased toward the steady-statevalue of ,tl. From 1945 to 1960, the capital-labor ratio in Germany increased for tr+'o rea-sons. First, total factor productivity growth was positive, so the growth rate of th:capital-labor ratio along the balanced growth path was positive. Second, Germany u..a-,converging from the capital-labor ratio of ft1ea5 toward the steady-state capital-labor rariaof F. Because the gron'th rate of the capital-labor ratio deterrnines the growth rate of reaiGDP per hour worked, the growth rate of real GDP per hour worked rvas also the resul:of balanced growth due to total factor productivity growth and growth due to the conver-gence of /D+s to y'. In general, I\re can think of the growth rate of real GDP per hou:worked as:

    gy = (Balanced gronth rate) + (Growthfrom convergence).As long as the capital-labor ratio is less than ts, growth from convergence is positive.

    so the German economy was growing more rapidly than it did along the balanced growthpath- Therefore, real GDP per hour worked converged toward y*, so real GDP per capitaconverged toward the balanced growth path. In the very different situation rvhere an econ-omy starts off with a capital-labor ratio that is greater than ts, the capital-labor ratio willdecrease over time, so grorvth from convergence will be negative. As a result, the econom:;will grow more slowlv than along the balanced growth path, so real GDp per worker \riiiconyerge to the balanced growth path.

    Figure 5. t4 shows that |apan experienced a similar decrease in real GDp per yp a:the end of the War and then rapid growth after the War.

    i i* i ie* Siates?In 2010, GDP per capita in the United States was more than six times higher than GDP pe:capita in China. However, the growth rate of real GDP per capita in the United States hasaveraged onJy i.9olo per year since 1980 compared to Chinat average rate of 8.9%o per yearover the same time period. Because China's standard of living is growing more rapidly thanin the United States, we could predict that China's standard of living will exceed the U.S,standard of living in the 1'ear 2038. However, for China to maintain ix high rates of grOwthin real GDP per capita, it lvould harc to maintain high rates of growth for total factor pro-ductiviry which is unlikely for several reasons. First, the United States invests more in activ-itieg such as research and developnrent, that result in new technologies and increases in totalfactor productivity. Second, much of Chinat growth is likeh due to the transition fron a

    "#ilf f,hina's 5t*ru#ar{$ #{, L$rr$rs#' #v*r ilw****$ tt"x-*-t *r"f tl-c*

  • The Balanced crowth path, Convergence, and Long-Run Equilibrium 171

    centrally planned economy to 1 mlka e31:T,u' * China's gowth rate is-likely to decrease

    as the transitioo i. **piriliil ;;;b"bly U.tt to thinliof the transition 1o a market

    economy as moving Cd;'t t"l;."i gt"t-tli p"th higher. The htgl tllt: of growth in real

    GDP per capita are d".;;;;;;;;;; tT.trigt'er g"'o$th.lath'e'l China approaches the

    new higher balanced gro;; p"fi, we would eipeciCttinut growth rate to decrease to a

    rnore sustainable rate.Anotherloomingproblemisdemographic.BecauseofChina!lowbirthrate,itwill

    ,oon experience a declina in its labor force. ouer the next two decades' the population of

    nren and lyomen u"*".nJi "ia

    ir y*tr will-fall by about 100 milhon, or about 30olo'

    China will also experien;;;i"A;.r!are ln oltler workers, a grouP thlt will likely be less

    e,lucated and less t "urtny;h;y";;g.r

    *orkers. Given current trends, the U.s. census

    Bureau projects f.*., ;;pi;;"iffiso i, china in 2030 than today, with ferver in their

    lOs and early 30s and many more intheir 69.:.*d older' More ominous is that China has

    :o national pubti. peorii-n'rffi. dti"a still has potential sources for enhancing produc-

    ;viqv, including the rnigi;;;_;f ,yil rvorkers ro *or. productive urban jobs and

    'iiderar'lication of t".hoi.uf 'k"o'-how' These factors can fuel future growth'

    but at some point'

    Jttir"t i""tographic problems could slow growth'The experienr" ,f i;;;;;; ,rrg rll two"decades offers a sobering lesson:

    Throughout

    :--re 1g70s, Iapan grew f;;; th"" the united states, and there rvas much discussion about

    n'hen fapan *oota ,,,,f-*-' 'tt"

    U"i1ta States in real GDP per capita' But in the 1990s'

    irpan s average annual ;r;;il;";. ;iler capita GDp rvas only 0.5016, well belorv the rate of

    :m*rrh of theunitedd;;,;J;rytit"ntiit*ted a decrease in the rate of growth of total

    :rctor productirity. Alth;;;n grr"li, i" Iapan"increased during the early 2000s, the coun-

    :-r has never approached the growth rates of *. 1o1rt beforJ 1990. \4rtrether china will

    ,f i" t"ff.t "

    ,"pii a"cnt't in grorvth rates remains to be seen'

    ---o*rrces: Nicholas Eberstadt, "The Demographic.Future," Foreign Aflairs,Vg! 8?:lo 5' November/

    le:ember 2010, pp. s+-+q; i[{u^,o ilayashi and.E-dward cl Prescott, "The 1990s in Japan: A Lost

    1...0.; " t*rrl.rninnuupolisfed'org/research / wp /wp617'pdf

    : ' . :v i l t i i r " rn i i * lsta** l i r tgbyd*i*gr* latedp; 'chi ' l l ;d ' ic ' i : * :gelSSalth*e*dafthis: i . - - ] i f i ' .

    ::r:tr*stsr##@'/"'2i*Xa!!)&!t*:A{t$H-t!tl.$ryLit*-'svjPl4y?*:$81+Ko'$itd'F!9q

    Figure 5.16 shows what the time paths ofreal GDP per capita would look like for an

    ionomy initially on tf'e ialanctJ g&lh p"th' an econ'omy initiAty Ptt:l S" bd-T:t1

    srowrh path, and "n

    .ron-o*y iniriiny uu*. the balanced growth path.If an economy rs

    ,-n the balanced growth prifr,'irr"*oins on the path until ari event moves the econom off

    *e path. When tfr. ..o"J"f it ""

    *f* f'"f*ced growth path' the grou4h rate of real GDP

    Time Path for a country initiallYabove the balancd growth Path

    6EE'ar iGOo2l-EOEo.io-EO8s6L.

    6z

    _ __ :- i_:r:::i::ii_

    :s:J'::i*i:':''

    Tirne Path for a country initiatlYbelow the balanced groMh Path

    Balanced growth Path

    Potential Time Paths forReal CDP Per Capitali an econotny is on the balanced

    growth path, it rentains on the

    path until an event m(|Yes theeconomy off the Path- If an econ-

    om,,v starts oii belorv the balanced

    grorvth Path,the economy Srolvsiaster than it would along the bal-

    anced gon'th Path. lf an econonystarts otf above ttre balancedgrowth Path, the economY gro\rs

    more slowlY than invould along

    the balanced grorvth P6[' sTime

  • 172 CHAPTER 5 r Long-Run Economic Growth

    #ffiffi Summary of Adjustunents to the Steady Statem growth frarn

    th* capital fa.bsF ratio .,. csnvergence is ...l f . . . and the grcwth rale *f the e{onorfif, ...k:k* equals the steady-state

    valuezero equals the balanced growth rate, and the econorny

    remains on the balanced growth path.k>k" is greater than the

    steady-state valuenegative is less than

    convergesthe balanced growth:rate, so the economy

    to the balanced growth path,k

  • The Balanced crowth path, convergence, and Long-Run Equiribrium 1r3

    fosease their saving rateg increase human capital, gr take other mcasures to increase totalfuctor productivity' tl-r9 gap in real GDp per capita betneen high-incorne and low-income'rauntries rvill never disappear.

    Answering the Key euestionAi the beginning of this chapter, we asked the question:' ',Vhy isn't the whole world rich?"

    Continued fram page i 43

    cur discussion has shown that the growth 1at9 oj labor productivity is the key determipant of theg'owth rate of the standard of livint. 8ut what determines *relrowtn rate oi raooifroauctivity;'{ccording to. the solow.growth.model, the growth rate of total"faaor productivity is the determinantof the growth rate of.labor productivity. As I resuh,,totar fagtor proau.tioity growth causes improve-ri''enE in the standard of living- and economic growth over the dn! ,un. we also saw that there is no

    f *ngfe{actor that causes total}actor productivily.to grow. The leveT of t"cr'notCihe qJdity of theI hq force, thequality of government and sociaf initituuons,-geolr"pt'y, ana triJ'qrJiiT-Lr tinanciatmsiitutions alf pfay an,important role. in explaining differencesTn t6tui ruao,. t;jr;ti;;il across countries.if a country fails to achieve sustained economic g-rowth then, it is due to its failure in one or more oflhese areas' Therefore, whife some countries 3t-" rirprv unlucky because of their geography, otf,ercountries are poor because of institutions that their go*rn*.ntt are unable, o. ,i*iirini to reform.

    _

    Befbre moving on to chapter 6, read An Inside Look on the nex.t page for a comparisonm':rojected econorhic growth rates in India and China.

  • AN INSIDE LOOK

    Will lndia Catch Up With China?

    The Fastest Lap:Indids Economy IsRacingwithCtrina'sNo other pair of countries invitesstrch frequent comparison yet shareso little in common. China is big-ger, stronger, richer and betterorganised than India, the onlYother country with over a billionpeople. And yet Indians, it is fair tosaf, et loy the comParisons withtheir northern neighbour morethan the Chinese do. It was anlndian rvho coined the wordChindia- lndia relishes being in thesalne league as China, eYen if itloses most of the games.

    In 201I, howel'er, India ma)'win a round- According to someprojections, its econorn)' rna)' gro\t-as fast as China's. [t mq'eYen growa little faster.

    g By the conYentions oi Indiannational accountitg, nst )'earbegins on April tst and ends onMarch 3lst }al[' over that P'eriod'the World Bank exPects lndia'seconom,v to grow by 8.790' slightl)'faster than the 8.506 growth it hasforecast for China oYer the calendar

    year. That is hardly the consensusview. But it is not an isolated oneeither. . . .

    Although only a handful ofeconomists think India's growthwill outpace China's next Yeer, alarger number believe it will do sothis decade. The reasons are largelydemographic. China's econonrYcannot go on rapidly expandingonce its labour force starts shrink-ing. Thanks to its one-child Poliry,introduced in L979,the number ofyoung Chinese ( I 5-29-year-olds)rvill fall quite sharply after 201 l,depriving the countrl"s factories ofnomadic, nimble-fingered r+'orkers.Within a couple of )ars, Chinese)'oungsters rr"ill be outnumbered bytheir tndian peers, even thoughIndia's population rvill not matchChina's until about 2025.

    O India rnay also outpace Chinarhis decad,e for the simple reasonthat it is poorer' giving it morescope to catch up. India's incomeper head rvould have to grow at \a/oa year for I 7 years to match theler"el China enjol's today. One yearof faster growth does not, then,mean that India is somehor,v over-taking China. Rather, it is like a5,000-metre runner doing a fasterlap than the frontrunner, who isfive laps ahead.

    O It would, nonetheless, be a rareachievement. India has not grownfaster than China since 1990. ' . ' IfIndia is to pip China again in 2011'several stars will also have to fallintoal ignrne,nt . . . .

    India s economY must maintainits momentum, despite its centralbank's campaign against stubbornlyhigh intlation. And China's mustslow appreciaL,ly. CLSA forecaststhat the Chinese econom,Y willgrolv by 8016 in 2011, down frorn10Vo in 2010.

    Such a (relatively) lorv exPecta-tion for growth reflects a highopinion of China's leaders. Thatsounds paradoxical-surelv slolvergrowth is a sign of Poliry failure,not success? But China's leaders noIonger seek growth at anY cost. [fthq, believe rvhat they saY; theYwould rvelcome a less breakneckpace of economic expansiofi. .

    -

    .

    India still has massive catchingup to do in infrastructure. It is notyet clear, with due respect to Indiannationalists, whether India willbecome the rvorld's fastest-growingbig economy in 2011' . . .

    Source; "The fastest laP: India'seconomy is racing with China's, " TheEconomist; November 22,2010' @ TheEconomist Newspaper Limited, London(Novernber 22, 2010).

  • Key Points in the Article*s a,tide discusses projected economicplrr*rth in lndia and China. After rnoret".ar 20 yean of traillng China in annualgqr*'ffi, some economic projections showmfi,e's growth rate rnay actually equaf orrr-r=ss Srat of China during this decade,Ie*eral factors have led economists tof'rs :cndusion, including (1) the growing;;;:: it India's labor force and (2) the factf.:: per capita incorne is less in India than

    'r- ,lnn.na, leading to a more rapid rate of

    rr-'r 3;gence between the two nations.

    i"maiyri*g the f.les$s61 Aiihough China's overafl populationf| q expected to outnurnber lndia's for1*r --ext 15 years, the size of theI*rri.es labor force will soon decline duer :re country's one-child policy, a popu-,,rtr'ir-control measure instituted in 1978t-c ,,innib most Chinese families to only:r-e :hild per household. Wthin the nextr*$q '/ears, lndia's population of" 5-:,r29-year-olds is projected to;rn,ass that of China, giving India air;6rgr', larger, healthier, and possiblyr{:re educated workforce. These derno-{,fas'xic changes will give India a bettertrirr,ltrrni$ to experience faster eco-'r'pl*', growth in the coming decades.1q {ccording to the ClAs WorldEl ;actboak,lndia's real CDP per capitalr,,n,,as 53,400 in 2010, less than one-half of

    ;:i'ficandy lower Wr capita income, lessmfr*i economic growth is needed in lndia',ira: in China for the annual percentagerT?ass in grow$r in these two nationstr :p{,tverge. Even if lndia does surpassl-rma in annual economic growth, Indiatffi a long way to go to overtake China inur :apta income. At an annual growth;rr: cf 8"/o,lndia would still need justr**,s'- 10 years to equal the per capitar-Lrl{:qe in China in 2010."q iven with a considerably lower per$t :"pita incorne, surpassing China'snr,r;al gowth rate would be a significantei:,:cmic rnilestone for India, as this feat-;s rct been achieved in more than 20,';-5 The figure shows actual and pro-ry::C gowth in CDP for lndia and Chinarrr* 2CO6 through 2015. The actual:rs--s through 2W9 show a consistently

    higher CDP growth rate in China than inIndia-with projections that the gap willnarow considerably in 2An; the gap willdisappear in 2A$; and lndia will overtakeChina in 2A16. Afew econornisb predictthat this gap will close even faster, per-haps as soon as 2011, but for this out-come to occur tndia must maintain itsgrowth momenturn while growth inChina will need to substantially subside.

    T}iIilIKINfi CRffiCALLY1. Labor productivity in emerging nations

    such as lndia and China has grownsignificantly in recent year. Thegrowth rate of tolal factor proCuctivityis the key determinant for labor pro-ductivity grawth and the growth rateof the standard of living when laborinputs per person are constant. Usingthe formulas for steady-state growthrates and the data in the table for2008, calcufate the annual increases inlabor productivi$ and real CDP forboth India and China. Based on Your

    answers, explain which of these coun-tries has a higher rate of growth in ibstandard of living.

    lndia t?air'a

    Capital's share of A37 0.58incomeTotal factor produc- 0,010 0.013tivity growth ratePotential labor 0.058 0.065hours growth rate

    2. Total factor productivity in emergingeconomies like those of lndia andChina is growing significantly, lead-ing to increased efficiency for bothworkei's and firrns. What effect doesan increase in ioLal factor productivityhave on the sieady-state values ofthe capital-labor i'atio and real CDPper hour vrorked? Wlty? Use agraph showing a one-time increasein total factor producivily to illus-trate your answei-.

    Stowing dragon,crouchlng tlgerGDP grorth, %

    2006 20a7 2008 2009 2010 2011 2012 z}fi 2A14 2015 2016Forecast

    Actual and proiected growth in CDR 2AA5-2015Source: O lhe Econonrist Nervspraper l.irnited,l,ondon (Novernber 22,2Ai0). s

    An lnside Look 175


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