Chapter 15 How Economies Grow Economic Growth Earlier

Chapter 15 How Economies Grow

Economic Growth • Earlier you learned that the growth in real GDP is often called economic growth. • However, when a nation grows economically, its citizens must be better off in at least some ways, usually in terms of their material well-being. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 15 -2

Economic Growth (cont. ) • Economic growth occurs when there are increases in per-capita output per unit time period, usually per year. Economic growth is measured by the annual rate of change in per-capita real GDP. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 15 -3

International Example • India has a total national output that is three times as large as that of Switzerland. • India’s population, though, is 125 times greater than that of Switzerland. • Thus, when we take into account the amount of output that is available to the average person, we can conclude that India is a relatively poor country and Switzerland is a relatively rich country. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 15 -4

Economic Growth and the Magic of Compounding • Some countries grow and others do not. You can see this in Table 15 -1, next. • There you see the annual average rate of economic growth in selected countries. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 15 -5

Table 15 -1: Per Capita Growth Rates in Various Countries Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 15 -6

Small Differences in Growth Matter • A small difference in the rate of economic growth may not matter for next year or the year after, but it surely does matter over longer periods. • It all has to do with the power of compounding. • The difference of one percentage point in our economic rate of growth over this nation’s history could have lead to three times our current standard of living. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 15 -7

Compounding Example • In 1626, Dutchman Peter Minuit arrived in Manhattan, charged by the West India Company with the task of administering the struggling colony. • Minuit purchased Manhattan Island from Native American Indians for the now legendary price of 60 guilders, or about $20. That $20 compounded at 6 percent would equal about $130 billion today, and at 7 percent about $5. 8 trillion today. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 15 -8

Saving: An Important Determinant of Economic Growth • Economic growth does not occur in a vacuum. It is not some predetermined fate of a nation. • Rather, economic growth depends on certain fundamental factors. One of the most important factors that affect the rate of economic growth and hence long -term living standards is the rate of saving. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 15 -9

A Basic Economic Growth Proposition • To have more consumption in the future, you have to consume less today and save the difference between your consumption and your after-tax income. • On a national basis, this implies that higher saving rates eventually mean higher living standards in the long run, all other things held constant. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 15 -10

A Basic Economic Growth Proposition (cont. ) • Saving is important for economic growth because if all income is consumed each year, there is nothing leftover for saving, which could be used by businesses for investment. • If there is no investment in our capital stock, there is little hope of economic growth. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 15 -11

A Basic Economic Growth Proposition (cont. ) • Data shows that in general, nations that have experienced high rates of saving have had greater economic growth rates than those that have not. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 15 -12

Productivity Increases—It’s What Economic Growth Is All About • Labor productivity is normally measured by dividing real GDP by the number of workers or the number of labor hours. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 15 -13

Productivity Increases—It’s What Economic Growth Is All About (cont. ) • Whenever average output produced per worker during a specified time period increases, we say that labor productivity has increased. • Clearly, there is a positive relationship between economic growth and increases in labor productivity. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 15 -14

Separating Different Rates of Growth of Production Inputs • If you divide all resources into just capital and labor, economic growth can be defined as the cumulative contribution to per capita real GDP growth of three components: – the rate of growth of capital, – the rate of growth of labor, and – the rates of growth of capital and labor productivity. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 15 -15

Growth in Technology • Technology has grown erratically in the United States and elsewhere. Nonetheless, there are some startling statistics about the growth in technology. • The greater the reward to those who innovate, the more technological advances we will get. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 15 -16

Growth in Technology: An Example • Microprocessor speeds currently exceed 3, 000 megahertz. By the year 2011, they will exceed 12, 000 megahertz. • During the same period, the size of the thinnest circuit line within a transistor will decrease by 80 percent. • By 2011, microchip plants will produce 1, 500 chips a week for every person on earth Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 15 -17

Research and Development • A certain amount of technological advance results from research and development (R&D) activities that have as their goal the development of specific new materials, new products, and new machines. • How much spending a nation devotes to R&D can have an impact on its longterm economic growth. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 15 -18

Innovation and Knowledge • Innovation involves the transformation of something new, such as an invention, into something that benefits the economy either by lowering production costs or by providing new goods and services. • Historically, technologies have moved relatively slowly from invention to innovation to widespread use. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 15 -19

The Importance of Human Capital • Knowledge, ideas, and productivity are all tied together. One of the threads is the quality of the labor force. • Increases in the productivity of the labor force depend on increases in human capital. • Human capital is the knowledge and skills that people in the workforce acquire through education, on-the-job training, and selfteaching. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 15 -20

How You Can Invest in Human Capital • To increase your own human capital, you have to invest by not working for pay while you attend school. • Society also has to invest in libraries and teachers. • According to modern economic growth theorists, human capital is at least as important as physical capital, particularly when trying to explain international differences in living standards. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 15 -21

Schooling is Important • Researchers have found that one of the most effective ways that developing countries can become developed is by investing in secondary schooling. • Teaching more children ages 12 to 18 may be more important than having a large network of colleges and universities in developing countries. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 15 -22

Property Rights and Entrepreneurship • If you lived in a country where bank accounts and businesses were periodically expropriated by the government, how willing would you be to leave your money in a savings account or to invest in a business? • You would be living in a political and economic system in which your property rights are not well defined and legally supported. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 15 -23

Property Rights and Entrepreneurship (cont. ) • The more certain property rights are, the more capital accumulation level will be, and therefore there will be greater economic growth. • Well defined property rights have usually been necessary for economic growth to occur. • Entrepreneurs will not take risks if they believe that their rewards from taking risks will be confiscated. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 15 -24

Key Terms and Concepts • • compounding economic growth human capital innovation labor productivity nationalization property rights research and development (R&D) Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 15 -25