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Chapter 16
Economic Growth
Slides to Accompany “Economics: Public and Private Choice 9th ed.”
James Gwartney, Richard Stroup, and Russell Sobel
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1. The Importance of
Economic Growth
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The Importance
of Economic Growth



Economic growth expands the sustainable output rate (YF)
of an economy.
This can be illustrated by either an outward shift in the
production possibilities curve . . . or an increase in long-run
aggregate supply (a shift from LRAS1990 to LRAS2000).
If monetary policy maintains the initial price level (P1),
equilibrium real GDP will increase from Y1990 to Y2000.
Consumption
Goods
B
Price
Level
LRAS1990
LRAS2000
SRAS1990
A
SRAS2000
PP2000
P1
PP1990
AD2000
AD
1990
A
Capital
B Goods
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Y1990
Y2000
Real
GDP
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The Importance
of Economic Growth




Differences in sustained growth rates over 2 or 3 decades
will substantially alter the relative incomes of countries.
The per-capita incomes for Argentina, Venezuela, Japan,
and Hong Kong in 1960 are indicated below.
During the 1960-1997 period, the per capita growth rates of
Argentina and Venezuela were 1% and 0.1% respectively . . .
in contrast, the annual growth rates of Japan and Hong Kong
were 4.7% and 6% respectively.
Note how the more rapid growth rates of the two Asian
nations drastically altered their relative incomes compared
to those of the two Latin American countries.
Per-Capita Income
(in Thousands of 1985 U.S. Dollars)
0
5
10
15
20
4,462
Argentina
1960
6,333
1997
6,338
Venezuela
6,505
2,954
Japan
Hong Kong
15,900
2,247
19,774
Source: Robert Summers and Alan Heston, Penn World Tables (Cambridge: National Bureau of Economic Research, 1994).
These data were through 1992. They were updated to 1997 by the authors.
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The Importance
of Economic Growth

The Rule of 70:


Dividing 70 by a country’s average
growth rate gives the number of years
required for an income level to double.
Example:
If the U.S. had a growth rate of 2.5%,
how many years would it take for the
income level of the U.S. to double?
70
= 28
2.5
28 Years.
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2. Differences in
Growth Rates
Among Nations
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Differences in
Growth Rates Among Nations
The Growth Of Per-capita GDP (1980–1998) Of High-income Industrial Countries,
High-Growth LDCs, And Low-Growth LDCs
HighGrowth
a
LDCS
China
South Korea
Taiwan
Singapore
Thailand
Ireland
Hong Kong
Growth Of
Per-capita GDP
1980–1998
8.2
6.4
5.4
5.4
4.9
4.3
4.2
High-Income
Industrial
Countries
Growth Of
Per-capita GDP
1980–1998
Japan
United Kingdom
Germany
United States
Australia
Italy
France
Netherlands
Canada
Switzerland
2.3
1.9
1.8
1.8
1.8
1.7
1.5
1.5
1.1
0.7
Low
Growth
LDCS b
Congo (Zaire)
Togo
Niger
Haiti
Nicaragua
Madagascar
Cameroon
Côte d’lvoire
Zambia
Romania
Growth Of
Per-capita GDP
1980–1998
-5.3
-4.1
-3.9
-3.6
-3.0
-3.0
-2.8
-2.6
-2.3
-2.2
Source: Derived from World Bank, World Tables, CD-Rom. Only countries with a population of 2 million or more are included in this
table. In a few cases, the 1998 data were unavailable. When this was true, the growth rate was for the 1980-1997 period.


The growth of LDCs (less- developed countries) is
characterized by diversity.
The fastest growing countries in the world are LDCs . . .
although other LDCs are doing very poorly.
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3. Sources of
Economic Growth
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Sources of
Economic Growth



Investment in physical and human capital
Technological advances
Institutions and policies consistent with
efficient economic organization, such as:






Secure property rights and political stability,
Competitive markets,
Stable money and prices,
Free trade,
Open capital markets, and,
Avoidance of high marginal tax rates.
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4. The Size of
Government and
Economic Growth
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The Size of Government
and Economic Growth


A Government that focuses on protective and
productive activities in which it has a
comparative advantage, can enhance growth.
Continued growth of government will
eventually exert a negative impact on the
economy, for 4 major reasons:




Higher taxes and/or additional borrowing will
impose increasing deadweight losses on the
economy.
Diminishing returns will cause the rate of return
derived from government activities to fall.
The political process is much less dynamic than
the market process.
A larger government becomes more heavily
involved in the redistribution of income and
regulatory activities.
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Size of Government—Growth Curve
Growth
Rate of the
Economy
B
6
3
A
0

Size of Government (As a Percent of GDP)
If governments undertake activities in the order
of their productivity, governments would, at first,
promote economic growth (increasing the size of
government from A to B) . . . at some point, though,
additional expenditures eventually would retard
growth (increasing the size of government beyond B
decreases the growth rate of the economy).
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Government Spending and Economic Growth
Among OECD Countries: 1960-1996


Here we show the relationship between the size of government at
the beginning of the decade and the growth rate of real GDP for
that decade (by decade for the 1960s, 70s, 80s, and 90s).
These data indicate that a 10% increase in government expenditures
as a share of GDP reduces the annual rate of growth by about 1%.
Respective Decade
Long Growth Rate
Growth = 7.84 - 1.16 (Gov’t Expenditures)
(-9.68)
Adj. R-Sq = .53
10.0
Linear trend
8.0
6.0
4.0
2.0
0.0
0.0
10.0
20.0
30.0
40.0
50.0
60.0
70.0
Total Government Expenditures (at beginning of respective decade)
Source: Derived from OECD Historical Statistics: 1960-1994 and OECD Economic Outlook: June 1999. The analysis
presented here is based upon 84 observations (4 decades and 21 OECD countries for which data were available).
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5. Economic
Freedom and Growth
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Economic
Freedom and Growth



Economists since the time of Adam Smith have
generally argued that freer economies are likely
to be more productive.
Economic freedom is complex and very difficult
to measure.
The Fraser Institute has developed a measure of
economic freedom. Their index indicates that
economic freedom is highest with:
 consistency of the legal structure,
 policies with secure property,
 monetary stability,
 free trade, and,
 reliance on markets.
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The Most and Least Free
Economies of the World


The Fraser Institute was able to assemble the required
data to rate the economic freedom of 119 economies in
1997. The summary ratings presented here are based on
data for 25 different components designed to identify the
consistency of institutions and policies with economic
freedom. The country ratings varied greatly.
Note that this index was designed to measure economic
freedom rather than political freedom, civil liberties, or
degree of democracy.
The Most Free And Least Free Economies In The World
Most Free Economies
Least Free Economies
9.6
9.4
Hong Kong 1
Singapore 2
New Zealand 3
United States 4
Unit. Kingdom 5
Canada 6
Argentina 7
Netherlands 8
Panama 8
Australia 8
Luxembourg 8
Ireland 8
9.2
9.1
9.0
8.8
8.7
8.6
8.6
8.6
8.6
8.6
0
3
6
4.2
4.2
4.2
4.2
4.2
4.1
4.1
4.1
3.5
3.2
Ukraine 108
C. Afr. Rep. 108
Algeria 108
Madagascar 108
Romania 108
Malawi 113
Sierra Leone 113
Albania 113
Rwanda 116
Congo, Dem. 117
Guin.-Bissau 118
Myanmar 119
9
3.1
2.5
0
3
6
9
Source: James Gwartney and Robert Lawson, Economic Freedom of the World: 1998-1999 Interim Report.
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Economic Freedom
and Economic Growth
Thousands
20
14829
12369
10
6385
2541
0
5
3057
4
3
2
1
6
5
4
3
2
1
0
-1
-2
-3
2.9
1.8
1.1
0.1
-1.9
5
4
3
2
1
1995 Economic Freedom Quintile
1995 Economic Freedom Quintile
(a) Per-capita GDP (1995 U.S. dollars)
(b) Growth of real GDP per capita, 1985–1996
Source: James Gwartney and Robert Lawson, Economic Freedom of the World: 1998-1999 Interim Report.

Countries with more economic freedom, as measured by
the Freedom Index in 1995, also had higher than average
per capita GDP and more rapid average growth rates
during 1985-1995.
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6. Is the Growth Trend
of the U.S. Changing?
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Is the Growth Trend in the U.S. Changing?
Annual
Growth
Rate of
Real GDP 8.0
• Despite the unprecedented
stability of the U.S. economy
during the past 15 years, the
average growth rate of real
GDP has fallen during each
of the last three decades.
3.2
2.8
2.5
4.0
0.0
Year
-4.0
1960
Change in
Output per
Hour Worked
• The growth of output per hour
worked during the ‘80s and
‘90s was less than half the
rate achieved during the ‘60s.
4.4
1970
1980
(a) Growth of real GDP
3.2
2.0
1990
1.2
1998
1.5
8.0
4.0
0.0
-4.0
1960
Year
1970
1980
1990
(b) Change in output per hour worked
1998
Source: Economic Report of the President, 1999, Tables B-2 & B-50
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Is the Growth Trend
in the U.S. Changing?

Factors favorable to economic growth
in the U.S. include:





the persistent low rate of inflation,
freer international trade,
a smaller share of output going to government, and,
the fact that a large part of the work force is just
moving into their most productive years.
These favorable factors may now be exerting
a positive impact on growth:


During 1995-1998, the average growth rate of real
GDP was 3.5%, better than that of the ‘70s and ‘80s.
The next couple of years will tell whether the recent
upturn in growth is temporary or more long-term.
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Questions for Thought:
1. What can government do to promote economic
growth? Is the role of government important?
Why or why not? As the size of government
increases as a share of the economy, how is the
growth rate of real GDP likely to be affected?
2. Discuss the importance of the following as
determinants of economic growth:
(a) natural resources,
(b) physical capital,
(c) human capital,
(d) technological advances, and,
(e) economic policy.
3. “Since government-operated firms do not have to
make a profit, they can usually produce at a lower
cost and charge a lower price than privately owned
enterprises.” Evaluate this view.
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End
Chapter 16
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