CHAPTER 5 The Reality of Economic Growth History

CHAPTER 5 The Reality of Economic Growth: History and Prospect 1 Copyright © 2002 by The Mc. Graw-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? 2 Copyright © 2002 by The Mc. Graw-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? 3 Copyright © 2002 by The Mc. Graw-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 4 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Table 5. 1 - Economic Growth through Deep Time 5 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Figure 5. 1 - World Population Growth since 1000 6 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 7 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 8 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 9 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Figure 5. 2 - Stylized Picture of the Demographic Transition 10 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 11 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Figure 5. 3 - Expected Population Growth Rates, 1997 -2015 12 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Figure 5. 3 - Expected Population Growth Rates, 1997 -2015 13 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 14 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 15 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Figure 5. 4 - Industrialized Areas of the World, 1870 16 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 17 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 18 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Figure 5. 5 - U. S. Measured Economic Growth: Real GDP per Worker 1995 Prices, 1890 -1995 19 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 20 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 21 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 22 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 23 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Table 5. 3 - The Magnitude of the Post-1973 Productivity Slowdown in the G-7 Economies 24 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 25 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 26 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Figure 5. 6 - Measured Real Mean Household Income, by Quintile 27 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 28 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 29 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Figure 5. 7 - World Distribution of Income Today, Selected Countries 30 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Figure 5. 7 - World Distribution of Income Today, Selected Countries 31 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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. 32 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Figure 5. 8 - Convergence among the G-7 Economies: Output per Capita as a Share of U. S. Level 33 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 34 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 35 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 36 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 37 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 38 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 39 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Figure 5. 9 - The Iron Curtain 40 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Table 5. 4 - The Iron Curtain: GDP-per-Capita Levels of Matched Pairs of Countries 41 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 42 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 43 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Figure 5. 10 - GDP-per-Worker Levels and Average Years of Schooling 44 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 45 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 46 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 47 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 48 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 49 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 50 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 51 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 52 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Policies for Technological Advance • Technological progress has two components – science – research and development • amounts to 3 percent of GDP in the U. S. 53 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 54 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 55 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 56 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 57 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 58 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 59 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 60 Copyright © 2002 by The Mc. Graw-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 61 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 62 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 63 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 64 Copyright © 2002 by The Mc. Graw-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 65 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 66 Copyright © 2002 by The Mc. Graw-Hill Companies, Inc. All rights reserved.