Economic Growth Professor Chris Adam Australian Graduate School

Economic Growth Professor Chris Adam Australian Graduate School of Management University of Sydney and University of New South Wales 1

INTRODUCTION • Observe rising incomes and standards of living • Know that level of GDP driven by – Capital – Labour – Technology • Changes in GDP must come from changes in factors 2

REAL GROWTH 3

GROWTH OF COUNTRIES 4

GROWTH MODEL • Solow-Swan growth model (1956) – “Dynamic capital accumulation” – Can explain how growth occurs – Can explain differences in growth – Key elements are savings and population growth – Technological progress also important but not covered here 5

GROWTH MODEL • Supply of goods and production Y = F(K, L) – Constant returns to scale – Analyze all quantities relative to labour force: Y/L = F(K/L, 1) or y = f(k) 6

GROWTH MODEL • Supply of goods and production – Slope of function is marginal productivity of capital per worker – Slope declines with increased capital per worker 7

LABOUR PRODUCTIVITY 8

GROWTH MODEL • Demand for goods and consumption – Output per worker divided between consumption goods and investment goods y=c+i – Omits government and international sectors 9

GROWTH MODEL • Demand for goods and consumption – Savings is fraction 0 < s < 1 of income, so consumption is c = (1 – s)y – Implies investment equals saving: i = sy 10

USING GROWTH MODEL • Capital stock growth and steady state – Investment (i) increases capital stock = savings (sf(k)) increases capital stock – Depreciation reduces capital stock: depreciation rate = d – Change in capital stock Dk then Dk = i – dk 11

USING GROWTH MODEL • Capital stock growth and steady state – Steady state when Dk = 0 – implying i = sf(k*) = dk* for k* steady state (constant) capital per worker 12

USING GROWTH MODEL • How savings affects growth – Increased savings rate (s) means less consumption per worker and more investment – Leads to higher level of capital stock per worker (k) – Strong empirical support 13

SAVINGS 14

USING GROWTH MODEL • What determines savings rates? • Similar investment rates do not always produce same income per worker – what else matters? 15

GOLDEN RULE OF GROWTH • Is more savings always good? – Gives larger capital stock per worker and higher output per worker – But reduces consumption per worker • Want to compare steady states to see which has highest consumption per worker 16

GOLDEN RULE OF GROWTH • Consider level of consumption at steady state c* = f(k*) – dk* Consumption is what is left of steady state output after allowing for steady state depreciation • Set level of savings to ensure c* is maximized: this is Golden Rule Savings – occurs when marginal product of k equals d 17

TRANSITION TO GOLDEN RULE • Too much capital per worker: – Policy maker lowers saving rate to Golden Rule level – Increases consumption and reduces investment – Investment rate now below depreciation rate – Reduces output, investment further – Consumption decreases from peak, but will remain above original level since at Golden Rule 18

TRANSITION TO GOLDEN RULE • Too little capital per worker: – Policy maker increases saving rate to Golden Rule level – Reduces consumption and increases investment – Investment rate now above depreciation rate – Increases output, investment further – Consumption increases from dip, and will remain above original level since at Golden Rule 19

POPULATION GROWTH • Growth in population increases workforce – Dilutes capital and output per worker at steady state – Population growth rate (n) reduces capital stock per worker in same way as depreciation Dk = i – (d + n)k = sf(k) – (d + n)k • Steady state k* from Dk = 0 = sf(k*) – (d + n)k* 20

POPULATION GROWTH • Growth in population has three effects on growth: – Better view of sustained growth drivers: total output grows – Better view of national income differences: higher population grow lowers GDP person – Golden Rule adjusted: now marginal product of capital per worker to equal (d + n) 21

TAKEAWAYS • Solow-Swan model shows – How saving sets steady state capital stock per worker and steady state income per worker – How population growth sets steady state capital stock per worker and steady state income per worker – What policy makers might do to maximize consumption per worker in steady state 22