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Ch. 8 Economic Growth
What are the sources of economic growth?
What are the prospects for the future U.S. growth rate?
I. Sources of growth: two categories
A. Growth that is “Extensive”
If more resources being used are at the root of the increased output, the growth in
the GDP is extensive. One can assess whether more inputs are being used among
each of the four factors of production:
Land – are more natural resources being used to fuel the growth?
Land includes acreage (surface area) water, minerals, trees. Market prices for
resources directly relate to their rates of extraction.
Labor – are people working more hours? Have new groups been
brought into the labor force?
Capital – the growth is extensive if it requires usage of more
machines, factories, and computers. The book gives the example of a city
necessarily having more capital than a small town.
Entrepreneurial activities – are more people taking the risk to start
their own business, to organize the necessary factors of production and selling their
output? If so, this too is a source of extensive growth.
You can see with all four that the key question for growth to be “extensive” is
whether more of a factor is required to fuel the output.
B. Growth that is “Intensive”
1.If the increased output is resulting not from more resources being
used but instead through more productive use of already working factors of
production, the growth is “intensive.”
It is more output as a result of greater productivity, which itself is often a
result of technological advancement.
Land – Technology improves over time to better extract resources
from the land, to extract these resources from ever more remote locations, and to
make it profitable to get resources from previously untapped forms, such as efforts
to gain petroleum from the “oil sands” of Alberta, Canada.
Labor – “Human Capital” is the education and skill level of a labor
force. When human capital rises, so does productivity.
Capital – Technological improvement, the better trained workforce,
and more efficient production processes can be sources of intensive growth
through capital improvement
Entrepreneurial activities – Computer programs, small business
coalitions or cooperative organizations can aid in the productivity of this factor of
production.
2. The introduction or strengthening of Economic institutions like the
corporation, the patent and other property protections, and contract
enforcement also help entrepreneurs. 200-201 describes the policies that do
this.
II. Productivity
A. Productivity is often defined by value of output/ unit of input where the
unit of input for, say, labor productivity, is an hour of work. So if a worker
can generate $100 of output for his firm in one hour, then the productivity
rate is $100/labor hour. To sum up, productivity-related gains are sources of
intensive growth while extensive growth involves more of a resource being
used.
B. A growth path steepens at first (over time, on the horizontal axis) and
then levels off (reaches a “stationary state”). Whether it levels off at a high
level as Adam Smith expected or a low level as Thomas Malthus expected
depends largely on (1) the rate of technological advancement and (2) the
interaction of population growth rates with the stage of the economy.
C. Technological change can be of two types: embodied or disembodied
1. Embodied Technological change is restricted to a given machine or
group of machines or other forms of capital. The assembly-line
manufacturing system, followed later by robotics in manufacturing, or
faster silicon chips to make machines work more rapidly are all examples
of Technological change that is Embodied in an identifiable unit or
category of capital.
2. Disembodied Technological change increases productivity of existing
capital without any identifiable improvement in any given piece of
machinery. Many examples can be found in the broad category of
infrastructure: roads, highways, bridges and public transport can all
improve a business’s productivity through speeding up employees and
distribution of a product. Electricity and other power plants as well as
communication systems are also significant to infrastructure.
D. Population Increase: During the U.S.’s agricultural and manufacturing
stages, population growth fueled a growing labor force, a primary source of
extensive growth.
In the predominantly service-based economy of the modern U.S., the
declining birth rate has been beneficial for per-capita real GDP (real GDP/
population).
How much capital is used per unit of labor? The capital-labor ratio has been
increasing as the U.S. has leaned toward capital-intensive rather than laborintensive production techniques. The increasing of a country’s capital-labor
ratio is called capital-deepening.
When, on the other hand, the capital-labor ratio is held steady by capital
usage growing proportionately with the labor force, it is called capitalbroadening
E. Malthusian Specter: the grim forecast that eventually demands of the
population will overwhelm food supplies. This prospect was based on a
partly valid simplification: food supplies grow arithmetically – by
increments - as population grows geometrically (roughly doubling with
successive generations).
Has this come true? Some countries certainly experience food shortages, but
with technological advancements in farming and rich countries that
subsidize farmers by guaranteeing a buyer (the government) when demand
is insufficient, the problem is not that there isn’t enough food, but the
obstacles to feeding the hungry.
F. What accounts for the slow down in US productivity growth rates?
1. Labor force composition: rising numbers of new entrants usually
bring down average productivity relative to highly experienced workers.
2. Output composition has gone from goods to services, requiring an
adoption of labor-intensive processes after a long trend of developing
capital-intensive techniques. Productivity typically rises more quickly in
capital than labor, so this change is a major cause of the falling U.S.
productivity.
3. Government regulations require expenditure by firms to ensure
compliance, as well as costly litigation when firms are found to be in
violation of the federal regulations governing their industry. These
expenditures do not contribute to more output being produced.
4. High fuel costs due to OPEC oil shocks encouraged firms to use
more labor rather than capital, although the actual impact on productivity of
this was minimal.
5. Decline in the rate of capital formation, which is a logical
extension of 2, the change in output composition.
G. The brighter viewpoint on Productivity
1.
A Princeton University Economist named William Baumol
argues that the productivity rate has just reverted to the U.S. historical level,
and it only looks to have slowed down since the rate through the 1950’s and
60’s was abnormally high.
a. The reasons for the high growth rates in this time period
were the unusually high population growth and the U.S.
economic recovery following WWII. As Robert Barro’s
research indicates, the 1.6% avg. annual growth rate is in line
with the long-run historical average, which, if you take the
1840-1990 time frame, is also 1.6%.
2.
As evidence of America’s strength, he notes the increasing
share of world manufacturing sales by U.S. companies from 1975-1988
3.
To the argument that service jobs are replacing manufacturing
jobs, Baumol responds that the same shift has been happening even more
rapidly in most every trading partner nation, and that this shift is itself due to
phenomenal gains in productivity in the manufacturing and agricultural
sector. For example, automation replaces some workers in manufactured
goods just as machinery eliminates much need for by-hand agricultural
labor; many of those who are displaced by job loss from the Goods sector of
the economy ended up finding ways to be productive in the Service sector.
H. R&D: Research & Development
1. Given that a substantial portion of GDP growth comes from
technological improvement, an argument can be made that Investment Tax
Credits could be offered by the government to encourage firms to spend on
R&D. Others have argued this is unnecessary since R&D spending by firms
as a fraction of the GDP has risen somewhat on its own.
I. How can the growth rate be increased?
1. Save more as a society and direct more of that savings to R&D
2. Invest in Human Capital (improve/expand education and skillstraining programs)
3. Make regulations and taxes more favorable to pro-growth
activities like capital formation, technological improvements, and
continuing education of employees.
4. Shrink Government, especially transfer payments which reduce
incentives for individuals to work.
III. Application 1: Military Spending
A. Economist Douglas Dowd writes that from 1946-71, 80% of Federal
Expenditures were in some way to pay for defense. He argues that this
spending has been a cornerstone of economic stability over the period.
Others point out that unemployment and weak economies (recessions) have
coincided with increases in military spending and tight labor markets and strong
economies (expansions) have coincided with declining military spending. The
exceptions, like 1953-54 when military spending fell and unemployment got
worse, do not appear likely to be predominantly explained by the cut in defense
spending. Other factors contributed to the unemployment rate rising from 2.9% to
5.6%. One of the most important was the “structural unemployment” as industries
transitioned from military to civilian goods.
B. As Arthur Okun’s comments on this reflect, the same expansionist
effect, more or less, would result if the government had spent the money
in a different way, such as mass transit systems, income support for the
poor, a tax cut for businesses, expanded college availability or a
nationalized health care system.
1. While an identical dollar value could be spent on other programs,
the actual economic result will depend on the specifics of the
program. As we have said, there are concerns that by reducing
incentives to work, income-stabilization programs may result in
growth that is unnecessarily low. Transit, health, and education
improvement would be viewed as more beneficial to long-term
productive capacity, as would the tax cut for businesses, especially
if it was specifically going to businesses that are spending on R&D
or new machines and factories (productive capacity).
2. There is also an ongoing debate about whether technological
change is encouraged or slowed by defense spending. Some argue
that money has been necessarily directed away from civilian uses
and represents lost R&D spending for numerous social causes.
Others point out that defense spending has been the source of
factory improvements, new machines and systems to
communicate, all of which improve private sector civilian
efficiency.
IV. Classical Economists as opposed to New Growth Theorists
A. Classical economists think (in brief, to be elaborated next chapter)
1. Savings leads directly to investment
2. The economy has self-correcting mechanisms to restore Potential (Capacity)
GDP at the natural rate of unemployment
3. Government spending should be low and balanced with taxes; therefore they
resisted deficits.
4. Say’s Law: Supply Creates It’s own Demand
Their emphasis on Diminishing marginal productivity of both labor and capital
leads to the leveled-off production function in Fig. 8-2 (192) which begins to
fall below subsistence output (the level at which consumption is enough for the
labor force to just survive) at quantities of labor to the right of L*. This
supposed leveling off is called a “stationary state.” It should be noted
Keynesians, explained next chapter, counter 1-4
B. New Growth Theory explained why the dire predictions of diminishing
marginal labor and capital (which combined with population growth implies the
Malthussian Specter described in II-C above) did not come true by emphasizing
the role of technology.
They describe the ripple effects of a given new invention or breakthrough as
positive externalities, where it is the work of one science or researcher that can
spawn the new discoveries of others, unforeseen by the person doing the
original work. This concept is most analogous to the
Disembodied Technological change in II-A-2 above.
Many industries have at least some significant period as they grow in quantity
of output where returns to scale are increasing (as in Fig 8-4).
Although, to the extent “network externalities” lock users in to what could be
obsolete technology if new versions were widespread, the accumulation of
positive externalities in a given network can be slowed.
C. Examples of Networks:
1. Telephones, cell phones
2. Internet
3. Roads, highways
4. Electrical power generation and usage
Common to networks:
All of these have very significant time periods where Returns to scale are
increasing, followed by some period of constant returns and finally when the
vastness of the enterprise creates some management oversight failing and some
of the firm’s operations become unwieldy, decreasing returns to scale.
Of course, the common characteristics of the networks described above do not
characterize a business that is not particularly part of a uniform network, such
as a sole proprietorship restaurant, coffee shop, or boutique retail store, where
diminishing returns to scale set in very quickly, at foreseeable and often readily
attainable output levels. The logic is that adding workers decreases marginal
productivity after the first dozen (or X # of) employees as there is crowding and
sharing of capital becomes increasingly problematic.