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CHAPTER 5
The Reality of Economic Growth:
History and Prospect
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Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Questions
• What is modern economic growth?
• What was the post-1973 productivity
slowdown?
– What were its causes?
– Is the productivity slowdown now over?
• Why are some nations so (relatively)
rich and other nations so (relatively)
poor?
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Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Questions
• What policies can make economic
growth faster?
• What are the prospects for successful
and rapid economic development in
tomorrow’s world?
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Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Looking Back into Deep Time
• 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
– population growth accelerated
– output per capita grew
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Table 5.1 - Economic Growth
through Deep Time
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Figure 5.1 - World Population Growth since 1000
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Premodern Economic
“Growth”
• Thomas R. Malthus
– first academic professor of economics
– introduced the idea that increases in
technology inevitably run into 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
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The End of the
Malthusian Age
• Over time, the rate of technological
progress rose
– by 1500, it was sufficiently high so that
natural resource scarcity could not
surpass it
– sustained increases in the population and
the productivity of labor followed
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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
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Figure 5.2 - Stylized Picture of the
Demographic Transition
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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
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Figure 5.3 - Expected Population Growth
Rates, 1997-2015
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Figure 5.3 - Expected Population Growth
Rates, 1997-2015
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The Industrial Revolution
• The industrial revolution began the
era of modern economic growth
– new technological leaps revolutionized
industries and generated major
improvements in living standards
• Great Britain was the center of the
industrial revolution
– English became the world’s de facto
second language
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The Industrial Revolution
• The new technologies were not
confined to Great Britain
– spread rapidly to western Europe and the
United States
– spread less rapidly to southern and
eastern Europe and Japan
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Figure 5.4 - Industrialized Areas of the
World, 1870
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American Long-Run Growth,
1800-1973
• Growth in the second half of the
nineteenth century was faster than it
had been in the first half
• Growth accelerated further in the
early part of the twentieth century
– a second wave of industrialization
occurred from new inventions and
innovations
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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
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Figure 5.5 - U.S. Measured Economic
Growth: Real GDP per Worker 1995 Prices,
1890-1995
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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
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American Long-Run Growth,
1800-1973
• Structural changes also occurred
– large drop in the proportion of the labor
force working as farmers occurred
– new methods of travel were developed
– large number of innovative technologies
and business practices were adopted
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American Long-Run Growth,
1800-1973
• The U.S. became the world’s leader
(in terms of technology) during the
twentieth century because
– 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
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American Economic Growth
Since 1973
• Between 1973 and 1995 measured
output per worker grew at only 0.6
percent per year
• The other major industrial economies
in western Europe, Japan and Canada
also experienced a slowdown in
productivity
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Table 5.3 - The Magnitude of the Post-1973
Productivity Slowdown in the G-7 Economies
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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
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American Economic Growth
Since 1973
• 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
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Figure 5.6 - Measured Real Mean Household
Income, by Quintile
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American Economic Growth
Since 1973
• Since 1995, productivity growth in the
U.S. has accelerated to a pace of 2.1
percent per year
• 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
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Modern Economic Growth
around the World
• The industrial core of the world
economy experienced a large increase
in its level of material productivity and
living standards during the nineteenth
and twentieth centuries
• Elsewhere the growth of productivity
levels and living standards was slower
• The world has become a more and
more unequal place
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Figure 5.7 - World Distribution of Income
Today, Selected Countries
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Figure 5.7 - World Distribution of Income
Today, Selected Countries
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Modern Economic Growth
around the World
• 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.
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Figure 5.8 - Convergence among the G-7
Economies: Output per Capita as a Share
of U.S. Level
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Modern Economic Growth
around the World
• 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
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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
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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
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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
• Steady-state capital-output ratios rose
• Diffusion of technology from the U.S.
occurred
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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
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Modern Economic Growth
around the World
• Many countries have not been so
fortunate
• Countries that have been ruled by
communists in the twentieth century
have remained poor
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Figure 5.9 - The Iron Curtain
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Table 5.4 - The Iron Curtain: GDP-per-Capita
Levels of Matched Pairs of Countries
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Sources of Divergence
• The principal cause of the large
variation in output per worker
between countries today are
differences in their steady-state
capital-output ratios
– differences in the share of investment in
national product
– difference in labor force growth
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Sources of Divergence
• A second cause of the large variation
in output per worker between
countries today are differences in the
level of education
– the efficiency of labor is highly correlated
with the level of education
• educated workers can use modern
technologies
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Figure 5.10 - GDP-per-Worker Levels and
Average Years of Schooling
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Sources of Divergence
• An additional cause of the large
variation in output per worker
between countries today are
differences in access to technology
– difficult to measure
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Cause and Effect,
Effect and Cause
• High population growth and low
output per worker go together
– rapid population growth reduces the
steady-state capital-output ratio
– poor countries have not undergone their
demographic transition
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Cause and Effect,
Effect and Cause
• Other vicious circles can occur
– poor countries will have a high relative
price of capital
• 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
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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
• The world’s industrial leaders provide
a benchmark of how much better
things could have been
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Hopes for Convergence
• Differences in productivity and living
standards between national
economies should be eroded over time
due to
– world trade
– migration
– flows of capital
– developing countries entering the
demographic transition
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Policies for Saving,
Investment, and Education
• 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
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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
• reducing tariffs and quotas
• subsidizing investment and expansion by
businesses that successfully compete in world
markets
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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
• the birth rate will likely fall
• the demographic transition will occur more
quickly
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Policies for Technological
Advance
• Technological progress has two
components
– science
– research and development
• amounts to 3 percent of GDP in the U.S.
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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
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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
• pace of technological improvement will slow
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Will Governments Follow
Good Policies?
• The broad experience of growth in
developing countries (with the
exception of east Asian and OECD
countries) has been that governments
often won’t
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Will Governments Follow
Good Policies?
• Typical systems of regulation in
developing countries have retarded
development by
– embarking on “prestige” industrialization
programs that keep resources from
shifting to activities in which the country
had a long-run comparative advantage
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Will Governments Follow
Good Policies?
– inducing firms and entrepreneurs to
devote their energies to seeking rents by
lobbying governments, instead of seeking
profits by lowering costs
– creating systems of regulation and
project approval that have degenerated
into extortion machines for
manufacturing bribes for the bureaucrats
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Will Governments Follow
Good Policies?
• 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
– governments should limit role to their
core competencies
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Chapter Summary
• Back before the commercial revolution
(before 1500 or so), economic was
very slow
– 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
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Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Summary
• The way out of the Malthusian trap
opened about 1500
– populations grew
– standards of living grew
– levels of material productivity grew
5-61
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Chapter Summary
• The industrial revolution was the start
of the current epoch: the epoch of
modern growth
– starting in the mid-eighteenth century,
the pace of invention and innovation
increased
• key inventions replaced muscle with machine
power
• material productivity levels boomed
5-62
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Chapter Summary
• Modern economic growth is welldescribed by the standard growth
model
– output per worker and capital per worker
increase at a pace measured in percent
per year
• the pace has been extraordinarily rapid in
long-term historical perspective
5-63
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Chapter Summary
• Looking across nations, the world is
an astonishing unequal place in
relative terms
– the gap between rich and poor nations in
material productivity is much greater
than it has ever been before
5-64
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Summary
• Combine the determinants of the
steady-state capital-output ratio with
the proximate determinants (the level
of technological knowledge and
average educational attainment in a
country after World War II) and you
can account for most of the variation
in the relative wealth and poverty of
nations today
5-65
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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 savings effort
– increase the rate of invention or
technology transfer
5-66
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.