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Questions • What is modern economic growth? • What was the post-1973 productivity slowdown? CHAPTER 5 The Reality of Economic Growth: History and Prospect 5-1 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. – What were its causes? – When did it end? • Why are some nations so (relatively) rich and other nations so (relatively) poor? 5-2 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Questions Before the Industrial Revolution • What policies can speed up economic growth? • What policy mistakes can slow down economic growth? • What are the prospects for successful and rapid economic development in tomorrow’s world? • Up until 1500, there had been almost zero growth of output per worker • After 1800, we see large sustained increases in worldwide standards of living 5-3 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Table 5.1 - Economic Growth through Deep Time Year 5-5 Population (millions) – population growth accelerated – output per capita grew 5-4 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Figure 5.1 - World Population Growth since 1000 Real GDP per Capita 5000 BC 5 $ 130 1000 BC 50 160 1 AD 170 135 1000 265 165 1500 425 175 1800 900 250 1900 1,625 850 1950 2,515 2,030 1975 4,080 4,640 2000 6,120 8,175 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 5-6 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 1 Premodern Economies • There are two principal reasons that there were no sustained increases in the productivity of labor before 1500 – resource scarcity – expanding populations Premodern Economies • Remember that Y/L depends on two factors – the economy’s capital intensity (K/Y) – the efficiency of labor (E) • The level of Y/L is therefore ! Yt ( K t % 1"! = & # (E t ) L t &' Yt #$ 5-7 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 5-8 Premodern Economies • Also remember that, in the long run, K/Y tends to approach an equilibrium Premodern Economies • Natural resources played an important role – sustained growth must be driven by sustained increases in the efficiency of labor – as populations grew, the stocks of natural resources had to be divided among more and more people – increases in technological capability induce increases in fertility that inevitably run into natural-resource scarcity • If productivity does not grow, it must be because labor efficiency did not grow 5-9 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 5-10 – first academic professor of economics – introduced the idea that increases in technology inevitably run into natural resource scarcity • We no longer live in a Malthusian age – for at least 200 years, new technologies and better organizations have made improvements in the efficiency of labor possible – these improvements have not been neutralized by natural-resource scarcity • implies that increases in technology lead to an increase in the size of the population but not to an increase in the standard of living 5-11 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. The End of the Malthusian Age Premodern Economies • Thomas R. Malthus Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 5-12 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 2 The End of the Malthusian Age • However, a Malthusian age may return The End of the Malthusian Age • It is likely that the population explosion is almost over – suppose that the population in the 21st and 22nd centuries grows at the same rate it did in the 20th century (1.33%) – the United Nations predicts that the world population will grow from over 6 billion today to around 10 billion by 2050 • the population will double in 72/1.33 = 54 years – after that, the population increase may stop as birth rates have been on the decline around the world • In 200 years, there would be nearly 90 billion people on earth 5-13 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 5-14 The End of the Malthusian Age • What caused the end of the Malthusian age? – the pace at which inventions occurred increased steadily The Demographic Transition • As material standards of living rise far above subsistence, countries undergo a demographic transition – birth rates rise – death rates fall – birth rates fall – by about 1500, technological progress passed the point at which it could offset increased scarcity of natural resources due to population growth 5-15 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 5-16 Figure 5.2 - Stylized Picture of the Demographic Transition Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. The Demographic Transition • In the world today, not all countries have gone through their demographic transitions – Nigeria, Iraq, Pakistan, and the Congo are projected to have population growth rates greater than 2% per year over the next generation 5-17 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 5-18 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 3 Figure 5.3 - Expected Population Growth Rates, Present-2020 5-19 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Figure 5.3 - Expected Population Growth Rates, 1997-2015 5-20 The Industrial Revolution • The industrial revolution began the era of modern economic growth Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. The Industrial Revolution • The new technologies were not confined to Great Britain – new technological leaps revolutionized industries and generated major improvements in living standards – they spread rapidly to western Europe and the United States – they spread less rapidly to southern and eastern Europe and Japan • Great Britain was the center of the industrial revolution – English became the world’s de facto second language 5-21 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 5-22 Figure 5.4 - Industrialized Areas of the World, 1870 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. The Industrial Revolution • Why did the Industrial Revolution take place in Great Britain and why did it occur around 1800? – the establishment of limited government, security of property, and freedom of contract in Great Britain after the Glorious Revolution of 1688 – the creation of modern science and the technological tradition of sustained inquiry into how the world worked 5-23 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 5-24 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 4 American Long-Run Growth, 1800-1973 • Growth in the second half of the 19th century was faster than it had been in the first half • Growth accelerated further in the early part of the 20th century American Long-Run Growth, 1800-1973 • During the late 19th century, the capital-output ratio increased greatly – the creation of railroads generated the possibility of supplying an entire continental market from a single factory – this encouraged investment by entrepreneurs – a second wave of industrialization occurred from new inventions and innovations 5-25 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 5-26 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Figure 5.5 - U.S. Measured Economic Growth: Real GDP per Worker 1995 Prices, 1890-2004 American Long-Run Growth, 1800-1973 • Growth slowed slightly during the Great Depression and World War II – 1.4 percent per year from 1929 to 1950 • Growth accelerated from 1950 to 1973 (2.1 percent) 5-27 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 5-28 American Long-Run Growth, 1800-1973 • Next to none of the growth since 1929 was the result of increases in K/Y – almost all of it was the result of increases in the efficiency of labor Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. American Long-Run Growth, 1800-1973 • Many economists believe that official estimates of output per worker overstate inflation and understate real economic growth by 1 percent per year – national income accountants have a hard time valuing the boost to productivity and standards of living generated by new inventions 5-29 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 5-30 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 5 American Long-Run Growth, 1800-1973 Table 5.2 – Labor-Time Costs of Commodities, 1895-1997 • Structural changes also occurred – a large drop in the proportion of the labor force working as farmers occurred – new methods of travel were developed – a large number of innovative technologies and business practices were adopted 5-31 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 5-32 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. American Long-Run Growth, 1800-1973 American Economic Growth Since 1973 • The U.S. became the world’s leader (in terms of technology) during the 20th century because • Between 1973 and 1995 measured output per worker grew at only 0.6 percent per year – the U.S. had an exceptional commitment to education – the U.S. was the largest market in the world – the U.S. was extraordinarily rich in natural resources – the U.S. avoided fratricide 5-33 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. – between 1950 and 1973, labor productivity growth had been 2.1 percent per year • The other major industrial economies in western Europe, Japan and Canada also experienced a slowdown in productivity 5-34 Table 5.3 - The Magnitude of the Post-1973 Productivity Growth Slowdown in the G-7 Economies Output-per-Worker Annual Growth (%) Country 1950-1973 1973-1995 United States 2.1 0.6 Canada 2.7 1.6 Japan 7.4 2.6 Britain 2.4 1.8 Germany (West) 5.7 2.0 France 4.4 1.5 Italy 4.9 2.3 5-35 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. American Economic Growth Since 1973 • Suggested causes of the productivity slowdown include – environmental protection measures – increased problems of economic measurement – the baby boom generation – the tripling of world oil prices in 1973 • The actual cause of the productivity slowdown remains a mystery 5-36 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 6 Effects of the Productivity Growth Slowdown Figure 5.6 - Measured Real Mean Household Income, by Quintile • Slower economic growth has made Americans feel much less well off than they had expected that they would be – for some workers, the post-1973 productivity slowdown has been accompanied by stagnant or declining real wages – increased income inequality has also occurred 5-37 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 5-38 Productivity Growth Speedup: The New Economy Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Figure 5.7 – Two-Year Growth Rates in Labor Productivity • Since 1995, productivity growth in the U.S. has accelerated – during the second half of the 1990s it was 2.1 percent per year – in the first half of the 2000s, it is 3.8 percent per year 5-39 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 5-40 Productivity Growth Speedup: The New Economy • Investment began rising in 1992 – business fixed investment grew at almost three times the rate of GDP • much of the additional investment has gone to purchase computers and related equipment • The recent acceleration in productivity growth was due to this boom in real investment 5-41 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Productivity Growth Speedup: The New Economy • Productivity growth continued to be quite rapid during the short recession of 2001, the uneven recovery of 2002, and the faster recovery periods of 2003 and 2004 – generally productivity growth slows during a recession – but business used investment in hightech equipment to continue to boost worker productivity during 2001 5-42 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 7 Modern Economic Growth around the World Figure 5.8 - World Distribution of Income Today, Selected Countries • The industrial core of the world economy experienced a large increase in its level of material productivity and living standards during the 19th and 20th centuries • Elsewhere the growth of productivity levels and living standards was slower • The world has become a more and more unequal place 5-43 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 5-44 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Modern Economic Growth around the World Figure 5.8 - World Distribution of Income Today, Selected Countries • The U.S. has not been the fastestgrowing economy in the world – a number of other countries at different levels of industrialization, development, and material productivity a century ago have now converged – their current levels of productivity, economic structures, and standards of living are very close to those of the U.S. 5-45 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 5-46 Figure 5.9 - Convergence among the G-7 Economies: Output per Capita as a Share of U.S. Level Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Modern Economic Growth around the World • By and large, the economies that have converged belong to the Organization for Economic Cooperation and Development (OECD) – group of countries that gave or received aid under the Marshall Plan to help rebuild or reconstruct after World War II 5-47 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 5-48 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 8 Modern Economic Growth around the World • The OECD countries adopted a common set of economic policies – large private sectors free of government regulation of prices – investment with its direction determined by profit-seeking businesses – large social insurance systems to redistribute income – governments committed to avoiding mass unemployment 5-49 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Modern Economic Growth around the World • The OECD countries ended up with mixed economies – markets direct the flow of resources – governments stabilize the economy, provide social-insurance safety nets, and encourage entrepreneurship and enterprise 5-50 Modern Economic Growth around the World • As the OECD countries became richer, they completed their demographic transitions • The policy emphasis on free enterprise boosted investment • Equilibrium capital-output ratios rose • Diffusion of technology from the U.S. occurred 5-51 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Modern Economic Growth around the World • Economic growth has not been limited to OECD countries – since World War II, several countries in east Asia have experienced stronger growth than has ever been seen anywhere in world history – these successful east Asian countries are somewhat similar to the OECD economies in terms of economic policy and structure 5-52 Modern Economic Growth around the World Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Table 5.4 - The Iron Curtain: GDP-perCapita Levels of Matched Pairs of Countries • Many countries have not been so fortunate • Countries that have been ruled by communists in the 20th century have remained poor 5-53 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 5-54 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 9 Modern Economic Growth around the World Modern Economic Growth around the World • Individuals living in countries outside of the Iron Curtain have higher levels of GDP-per-capita • Even if attention is confined to noncommunist-ruled economies, there has still been enormous divergence in relative output-perworker levels over the past 100 years – they may not have better education, health care, or a more favorable income distribution 5-55 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 5-56 Sources of Divergence • The principal cause of the large variation in output per worker between countries today are differences in their equilibrium capitaloutput ratios Sources of Divergence • Two secondary causes of the large variation in output per worker between countries today are – openness to creating and adapting the technologies that enhance the efficiency of labor – the level of education today – K/Y is determined by • the level of investment • the growth rate of the labor force 5-57 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 5-58 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Cause and Effect, Effect and Cause Figure 5.10 - GDP-per-Worker Levels and Average Years of Schooling • High population growth and low output per worker go together – rapid population growth reduces the equilibrium capital-output ratio – poor countries have not undergone their demographic transitions 5-59 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 5-60 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 10 Cause and Effect, Effect and Cause • Other vicious circles can occur – poor countries will have a high relative price for capital equipment Hopes for Convergence • The context of economic “stagnation” and “failure” are relative terms – net national product in Argentina is about three times what it was in 1900 – net national product in Norway is about nine times what it was in 1900 • this implies that poor countries get less investment out of any given effort at saving – good education is harder to provide in poor countries • Setting the demographic transition in motion will offset these problems 5-61 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. • The world’s industrial leaders provide a benchmark of how much better things could have been 5-62 Policies for Saving, Investment, and Education Hopes for Convergence • Differences in productivity and living standards between national economies should be eroded over time due to • Policies to boost saving include – ensuring that savers get a reasonable rate of return on their savings – minimizing restrictions on entrepreneurship – keeping inflation low – keeping government deficits to a minimum – world trade – migration – flows of capital – developing countries entering the demographic transition 5-63 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 5-64 Policies for Saving, Investment, and Education • Policies to boost investment for a given level of savings include – welcoming money from foreign investors – allowing businesses to freely earn and spend foreign exchange Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Policies for Saving, Investment, and Education • Promoting universal access to education can provide two important benefits – a better-educated workforce is likely to be more productive – educated women will likely pursue opportunities outside the home • reducing tariffs and quotas • subsidizing investment and expansion by businesses that successfully compete in world markets 5-65 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. • the birth rate will likely fall • the demographic transition will occur more quickly 5-66 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 11 Policies for Technological Advance • Technological progress has two components – science – research and development • amounts to 3 percent of GDP in the U.S. and other industrial economies 5-67 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Policies for Technological Advance • Governments seeking to establish patent laws face a dilemma – if the patent laws are strong, much of the modern technology in the economy will be restricted in use – if the patent laws are weak, profits that innovators and inventors can earn will be low Policies for Technological Advance • Businesses conduct investments in research and development to increase profit • Research and development is a public good – other firms can copy it – patents limit the ability of other firms to do so 5-68 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Government Failure • The broad experience of growth in developing countries (with the exception of east Asian and OECD countries) has been that governments often will not create policies that assist in growth and development • pace of technological improvement will slow 5-69 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 5-70 Government Failure • Typical systems of regulation in developing countries have retarded development by – “prestige” industrialization programs – inducing firms and entrepreneurs to devote their energies to seeking rents – creating systems of regulation and project approval that have become extortion machines for manufacturing bribes for the bureaucrats 5-71 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Government Failure • Neoliberalism describes much of the recent thinking about the proper role of government in economic growth – the government has a sphere of core competencies at which it is effective • administration of justice, maintenance of macroeconomic stability, provision of social insurance, some infrastructure development 5-72 – governments should limit role to their core competencies Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 12 Chapter Summary • Back before the commercial revolution (before 1500 or so), economic was very slow Chapter Summary • The way out of the Malthusian trap opened about 1500 – populations grew – standards of living grew – levels of material productivity grew – populations grew at a glacial pace – there were no significant increases in standards of living for millennia before 1500 – humanity was caught in a Malthusian trap 5-73 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 5-74 Chapter Summary • The Industrial Revolution was the start of the current epoch: the epoch of modern growth Chapter Summary • Modern economic growth is welldescribed by the standard growth model – starting in the mid-18th century, the pace of invention and innovation increased – output per worker and capital per worker increase at a pace measured in percent per year • key inventions replaced muscle with machine power • material productivity levels boomed 5-75 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. • the pace has been extraordinarily rapid in long-term historical perspective 5-76 Chapter Summary • Productivity growth rates slowed down worldwide after 1973, causing living standards to rise more slowly in the 1970s and 1980s Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter Summary • Productivity growth rates sped up after 1995 and continue at this higher pace – the acceleration was due to a boom in real investment in computers and related equipment – several explanations have been offered for this productivity growth slowdown, but economists generally agree the causes remain a mystery 5-77 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 5-78 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 13 Chapter Summary • Looking across nations, the world is an astonishingly unequal place in relative terms – the relative gap between rich and poor nations in material productivity is much greater than it has ever been before 5-79 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter Summary • Combining the determinants of the balanced-growth capital-output ratio with the proximate determinants (the level of technological knowledge and average educational attainment in a country after World War II) accounts for most of the variation in the relative wealth and poverty of nations today 5-80 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter Summary • Macro policies to increase economic growth are policies to – accelerate the demographic transition (through education) – increase savings rates – boost the amount of real investment a country gets for a given saving rate – increase the rate of invention or technology transfer 5-81 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 14