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Chapter 11
The Big
Questions of
Economic
Growth
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
The Big Questions of Economic
Growth
• Why are we so rich and they so poor?
– More than half of the world’s population lives on less than $3,200
per year, 1/10 of the $32,000 average level of U.S. per person
consumption.
• What creates a growth miracle?
– A “growth miracle” is a country that experiences sustained growth
rates of 5% or more for several decades.
• What caused the worldwide growth slowdown and
subsequent revival?
– The period of most rapid growth in the U.S. was between 1913 and
1973. Growth slowed until 1995, and then picked up again in the
1995-2007 period.
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11-2
Figure 11-1 Saving, Investment,
and Capital Per Hour in Long-run
Equilibrium for a Poor Nation
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11-3
Figure 11-2 Output per Hour of
Rich and Poor Nations During the
Period of Convergence
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11-4
Standard of Living vs. Labor
Productivity
• “Output Per Person,” “Labor Productivity,” and “Output
Per Hour” all can be represented by Y/N.
– The growth rate of Y/N = y – n
• The growth rate of labor input (n) does not need to equal
the growth rate of the population (q).
– Example: The increase in women participation in the labor force
caused n > q in the 1970s and 1980s.
• The Standard of Living is real GDP per member of the
population, or “Real Output Per Capita.”
– The growth rate of the standard of living = y – q
– The difference in labor productivity growth and the growth of a
country’s standard of living = n – q
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11-5
Multifactor Productivity
• Recall: Multifactor Productivity (MFP) differs from labor
productivity in that it expresses the amount of output
produces relative to both labor and capital inputs (not just
relative to the labor inputs only).
– The growth rate of MFP is given by:
a = y – bk – (1 – b)n
where b is the elasticity of output to capital and
(1 – b) is the elasticity of output to labor
– To compare a to the growth rate of labor productivity (y – n), we can
rearrange the above equation to yield:
a = (y – n) – b(k – n)
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11-6
Productivity and Real Wage Growth
• If labor productivity (Y/N) grows slowly, the real
wage (W/P) also tends to grow slowly. Why?
• (1 – b) from the equation for MFP can be
estimated as labor’s share of national income:
Labor’s share = 1 – b = WN  W P
PY Y N
• Expressed in term’s of growth rates:
Growth rate of labor’s share = (w – p) – (y – n)
• If the growth rate of labor’s share of income is
zero, then the real wage grows exactly at the rate
of labor productivity!
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11-7
The Failure of Convergence
• The Solow model predicts that poor countries will converge
to the same level of output per capita of rich countries.
– A key empirical prediction is that poorer countries will have faster
rates of growth of labor productivity.
• Problem: While many countries converge empirically,
several chronically poor countries do not.
• One way to adjust the Solow model to account for this
failure of convergence is to remove the unrealistic
assumption that all nations have the same production
function, saving rate, n, and d.
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11-8
Figure 11-3 Output per Worker Relative to
the United States in 1960 and the Growth of
Output Per Person, 1960–2004
Source: Alan Heston, Robert Summers, and Bettina Aten, Penn World Table Version 6.2, Center for International Comparisons of Production, Income,
and Prices at the University of Pennsylvania, September 2006. See pwt.econ.upenn.edu/php_site/pwt62/pwt62_form.php.
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11-9
Table 11-1 Examples of Countries Displaying
Convergence, Anti-Convergence, or Neither (Levels
and Growth Rates in Percent)
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11-10
Figure 11-4 The Effect of a Low Saving
Rate or High Rate of Population
Growth on Output Per Person
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11-11
Technological Change and
Human Capital
• The Solow model assumes unrealistically that the rate of
technological change is the same in every country and the
best available technology is freely available to all countries.
• How can poor countries acquire technology given that most
research takes place in rich countries?
–
–
–
Engineers in poor countries can copy modern products made in
rich countries.
Poor countries can purchase imported machinery that embeds the
latest technology.
Poor countries can obtain investment by foreign firms.
• But poor countries may also need additional human capital
to use acquired technology.
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11-12
Political Capital, Infrastructure, and
Geography
• Recently economists have identified fundamental
underlying sources of growth that help us understand why
some countries “take off” while others do not.
• The legal and political environment
– The free market system requires that entrepreneurs who take risks
have a high probability of making a decent profit.
• The legal system must protect private property.
• The tax system must be fairly administered so “diversion” is minimized
as it reduces profits.
– Infrastructure is crucial, for instance, in the production of highways,
airports, ports, telephone networks, and electricity systems.
• Geography cannot be controlled by the government but
also plays a role.
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11-13
Physical Infrastructure and
Growth
• Infrastructure is any type of capital not
owned by the individual business firm that
makes the firm’s production more efficient.
– Example: Highways, railroads, airports, and ports
• In some poor countries the value of a business
investment is reduced by poor highways and
airports and other shortages of physical
infrastructure.
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11-14
Geography and Growth
• Jeffrey Sachs of CU proposed four hypotheses regarding
the role of geography in growth:
– Technologies developed in temperate areas may not be applicable
to tropical areas.
– Technological development often involves high development costs
and low production costs suitable to large economics.
• Small economies in tropical regions may be too small to justify
significant investment.
– Poor productivity in rural agriculture in tropical countries and the
prevalence of tropical diseases directly affect population growth.
– Colonial domination of many tropical countries impeded the
process of economic growth by neglecting the formation of human
capital.
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11-15
The 1973-95 Productivity
Slowdown
• Here are the leading explanations for why
productivity growth slowed in from 1973-95
– The growth of K/N slowed because k slowed and n
increased.
– Higher energy prices led to a large slowdown in energy
dependent industries.
– More teenagers and women caused a slowdown in
productivity, or else the slowdown was measured
because of discrimination against women.
– Inadequate infrastructure investment may have caused
productivity to slow.
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11-16
Figure 11-5 Growth Rate of Labor
Productivity in the United States,
1960–2007
Source: Bureau of Labor Statistics data for the nonfarm private business sector.. Details in Appendix C-4.
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Figure 11-6 The Effect on the Labor Market
of an Adverse Productivity Shock and a
Downward Shift in Labor Supply
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11-18
Figure 11-7 Level of Labor
Productivity in Europe and the
United States, 1970–2006
Source: Groningen Growth and Development Center, Total Economy Database. Details in Appendix C-4.
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Chapter Equations
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Chapter Equations
y  q   y  n  n  q
(11.1)
a  y  bk  1  b  n
(11.2)
General Form
Numerical Example
a   y  n   b  k  n  2.25   4  1  0.25  4  1
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(11.3)
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Chapter Equations
WN W P
Labor's share  1  b 

PY Y N
(11.4)
Growth rate of labor's share   w  p    y  n  (11.5)
Condition if the growth rate of labor's share is zero
w p  y n
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(11.6)
11-22
Chapter Equations
Y  AF  K , H , N 
Y  A G, P,T  F  K , R, H , N 
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(11.7)
(11.8)
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