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Chapter 26 - Economic growth. In this chapter you will learn: How to calculate growth rate of real GDP per capita? What the relationship between productivity and growth is? What the factors that determine productivity are? Why there are differences between a country’s level of income and its rate of growth?...
Chapter 26 Economic Growth © 2014 by McGraw-Hill Education What will you learn in this chapter? • How to calculate growth rate of real GDP per capita • What the relationship between productivity and growth is • What the factors that determine productivity are • Why there are differences between a country’s level of income and its rate of growth • How to assess evidence for and against convergence theory • How good governance and economic openness can promote growth © 2014 by McGraw-Hill Education Economic growth through the ages Rapid economic growth is a modern phenomenon During the 1800s, economic activity increased substantially • During the 1900s, GDP grew faster than population, raising the standard of living for many History of world economic growth: GDP per capita, 1000 BC to 2000 AD • Millions of people/ constant U.S dollars In the last 50 years, global GDP per capita quadrupled 9,000 8,000 7,000 6,000 5,000 4,000 Little to no GDP growth 3,000 World GDP Population Industrial Revolution 2,000 1,000 -1000 1000 1500 © 2014 by McGraw-Hill Education 1800 Year 1900 1950 1975 2000 Economic growth through the ages • From the previous chapter, we learned that combining real GDP with population data yields real GDP per capita – Real GDP per capita describes the change in purchasing power for each person over time • Given the growth rate in nominal GDP, real GDP per capita growth rate is calculated as: real GDP per capita growth rate = nominal GDP growth rate – inflation rate – population growth rate © 2014 by McGraw-Hill Education Active Learning: Growth in Real GDP per capita Use the equation for calculating real GDP per capita growth to fill in the missing values Country Nominal GDP Growth (%) Inflation (%) Population Growth (%) Panama 15.4 1.4 Guatemala Italy 1.2 Real GDP per capita Growth (%) -2.4 © 2014 by McGraw-Hill Education Compounding and the rule of 70 • Economic growth builds on itself over time • This process is similar to compounding interest in a savings account • A small annual growth rate can add up to a large change in an economy over time Constant 2010 U.S dollars 50,000 45,000 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 Year © 2014 by McGraw-Hill Education • U.S average annual growth in real GDP per capita was 2% during the last century • This equates to real GDP per capita being times larger in 2010 than 1910 Compounding and the rule of 70 • Total change in GDP over time is bigger than the annual growth rate suggests • Using an average growth rate and any year’s GDP, GDP in the future can be estimated • GDP per capita in any year: GDPYear A = GDPYear B × (1 + Growth rate)(year A – year B) • A simple shortcut to understand how many years it takes for GDP to double is the rule of 70: 70 Years until income doubles = real GDP growth rate © 2014 by McGraw-Hill Education Active Learning: Forecasting GDP Use the following information to forecast the real GDP per capita in 2015 Country 2013 Real GDP per capita ($) Real Growth Rate (%) France $40,000 Spain $30,000 2015 Real GDP per capita ($) © 2014 by McGraw-Hill Education Active Learning: Forecasting GDP Use the rule of 70 to estimate how many years it will take for the income in each country to double Country 2013 Real GDP per capita ($) Real Growth Rate (%) 2015 Real GDP per capita ($) France $40,000 $41,616 Spain $30,000 $30,120 © 2014 by McGraw-Hill Education Years until income doubles Determinants of productivity • Productivity is a measure of the output per worker and is what drives growth • The only way to consume more and enjoy a higher standard of living is to increase the amount each person produces • The standard of living in a country is driven by the average productivity of its workers – Increases in productivity per person increases in per capita income = economic growth © 2014 by McGraw-Hill Education 10 Components of productivity • There are several components of productivity – Physical capital is the stock of equipment and structures that allows for production of goods and services – Human capital is the set of skills, knowledge, experience, and talent that determine she productivity of workers – Technological improvements are innovations that cause the same inputs to produce more outputs – Natural resources are production inputs that come from the earth © 2014 by McGraw-Hill Education 11 Rates versus levels • Imagine you are driving a car and merging onto the highway You start at 15 mph and are at 25 mph seconds later – Your level of speed is low, but your rate of change is high • Once you are on the highway, you cruise at a speed of 55 mph – Your level of speed is high, but your rate of change is zero • This analogy is useful for thinking about the differences between wealthy countries and fastgrowing countries © 2014 by McGraw-Hill Education 12 Convergence Convergence theory states that countries that start out poor will grow faster than rich ones and eventually converge to the same growth rate as the rich ones © 2014 by McGraw-Hill Education 13 Growth and public policy • Recent history has shown that a few decades of strong economic growth can transform lives through increases in standard of living • Public policy responses aim to spark and sustain growth • There is no one-size-fits all policy © 2014 by McGraw-Hill Education 14 Investment and savings • Investment trade-off is a reduction in current consumption to pay for investment in capital intended to increase future production • Domestic savings is savings for capital investment that come from within a country – Domestic savings comes from two sources: Households spending less than they earn Government revenues exceeding non-capital expenditures domestic savings = domestic income - consumption spending © 2014 by McGraw-Hill Education 15 Investment and savings Household saving rates greatly vary across countries Household savings rates among countries • Developing nations tend to save more • Developed nations tend to save less Savings (% of disposable income) 40 35 30 25 20 15 10 Japan United States Brazil United Germany Kingdom India China © 2014 by McGraw-Hill Education 16 Investment and savings • Foreign direct investment (FDI) is when a firm runs part of its operation abroad or invests in another company abroad Benefits Costs • Governments actively work • Firms might demand to attract FDI when special tax breaks or legal domestic savings aren’t exemptions large enough • Human capital and • Can result in human capital technology transfer is not transfer from foreign firms guaranteed to local workers © 2014 by McGraw-Hill Education 17 Education, health, and technological development • Education: One of the most important ways that a country can increase its human capital is by ensuring that high-quality public education is freely available to all children • Health: Workers who are in good health will be more productive • Technological development: Helps countries improve the productivity of existing inputs © 2014 by McGraw-Hill Education 18 Good government, property rights, and economic openness • Enforceable laws and effective, trustworthy government services are critical to a wellfunctioning economy • Most countries have mechanisms to: – Punish those to violate others’ property rights – Enforce contracts between buyers and sellers – Settle disputes • Additionally, it is important for countries to have stability in leadership © 2014 by McGraw-Hill Education 19 The juggling act • There are trade-offs between different ways of promoting growth through public policy – Many governments cannot pay for all of the factors that promote growth at once – The poorer the country, the harder the trade-off – This “poverty trap” is one of the main justifications for foreign aid that provides loans or funding for investment and development – There are trade-offs associated with economic growth and natural resource sacrifices © 2014 by McGraw-Hill Education 20 Summary • National economic growth builds on itself over time (compounding), which means that a modest annual growth rate can add up to large growth over time • The real GDP growth rate is found by subtracting population and inflation growth rates from the nominal growth rate • The rule of 70 gives an estimate of how long it will take incomes to double within a country © 2014 by McGraw-Hill Education 21 Summary • Increasing productivity is the only way that a country can consume more and enjoy a higher standard of living • Productivity is often measured as output per worker • The factors that influence labor productivity are physical capital, human capital, technology, and natural resources © 2014 by McGraw-Hill Education 22 Summary • It is important to distinguish between levels of well being and the rate of economic growth • The convergence theory predicts that countries that start at lower incomes will grow at a faster rate than those with higher incomes until they catch up and converge to the same growth rate • Real world evidence does not always fit to the convergence theory © 2014 by McGraw-Hill Education 23 Summary • Countries make investment-tradeoffs where current consumption is decreased to pay for investment for future production • Capital investment can come from domestic savings or foreign direct investment (FDI) • Education, public health, and technological development policies can promote economic growth • Good governance and economic openness lay the foundation for growth © 2014 by McGraw-Hill Education 24 ... Inflation (%) Population Growth (%) Panama 15.4 1.4 Guatemala Italy 1.2 Real GDP per capita Growth (%) -2 .4 © 2014 by McGraw-Hill Education Compounding and the rule of 70 • Economic growth builds on... • Given the growth rate in nominal GDP, real GDP per capita growth rate is calculated as: real GDP per capita growth rate = nominal GDP growth rate – inflation rate – population growth rate ©... responses aim to spark and sustain growth • There is no one-size-fits all policy © 2014 by McGraw-Hill Education 14 Investment and savings • Investment trade-off is a reduction in current consumption