Growth

1
Growth

• Lets start with a bit of a joke, or maybe a mind
  teaser. Say you are in a bar or restaurant with
  10 other people. Then Bill Gates walks in. What
  happened to the per capita income of the people
  in the bar? It rose! Are you any better off?
  Not unless Bill gives you some of his income!
• In Econ, we look at increases in RGDP per capita
  as a sign that we are better off!

2
Digress the handy rule of 70 (Some people say
72) This idea is about the number of years it
takes something to double in size if growing at
rate r (this is an approximation, but a handy
rule none the less) 70 divided by r, where r is
expressed as a , not a decimal. Example 3
growth a year ? 70/3 23.33 2 growth a
year ? 70/2 35
3
So with a RGDP growth rate at 3 the size of the
economic pie doubles about every 23 years. If
growth is only 2 it takes about 35 years for the
size of the economy to double. Why should we care
about the growth? Well, the population tends to
grow, does it not? And the growing population
wants a good standard of living, right? So, keep
the growth rate up to keep the standard of living
(in the sense of per capita income the RGDP
divided by the population) at least constant, or
better yet, growing.
4
Remember we noted two things about the RGDP in a
previous chapter. 1) Over the long haul, or long
term, RGDP has moved upward and this is called
economic growth. 2) In the short term there are
economic fluctuations - ups and downs in the
level of RGDP. This shorter term pattern is
often called the business cycle. Two ideas we
want to consider about the long term, associated
with the RGDP, are the RGDP per capita and the
RGDP per capita growth rate.
5
RGDP per capita is the RGDP divided by the
population. In this sense it is a measure of
what people get on average. It is generally
thought that as the RGDP per capita gets larger
the standard of living, or economic well-being,
of the country is growing. In the year 2000 the
RGDP per capita in the US was around 34,260.
The growth rate was, on average, 1.81 for the US
for the period of time 1870, yes 1870, to the
year 2000. 1.81 growth means the economy doubled
in size every 70/1.81 39 years or so. So over
the 130 years the US economy doubled in size
roughly 4 times (in per capita terms.)
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Lets perform a trick that will show us an
interesting result. You and I now know that
RGDP per capita RGDP/Pop. Here is the trick.
Lets multiply this definition by 1, where 1
the number of workers divided by the number of
workers. We get RGDP per capita
(RGDP/Pop)(number of workers/number of workers)
and then rearranging we get RGDP per capita
(RGDP/number of workers)(number of
workers/Population). If here Y RGDP Y/POP
(Y/N)(N/POP). Y/N is called average labor
productivity. So, the RGDP per capita depends in
part on the average labor productivity.
7
Here we study what can make average labor
productivity grow. 1) Work harder. If labor
works harder than perhaps productivity can grow
and we can get more output per worker. But, this
method of getting output is just one, and
probably not the most important, factor in
increasing labor productivity. 2) Human capital.
Human capital refers to talents, education,
training and skills of workers. You what to know
something? It is easy to kick someone in the
face when you are standing on their shoulders. I
mention this because down through the ages we
have accumulated knowledge about how to do
things. In the present day we build on what we
have learned from the past and this has certainly
increased our average labor productivity.
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3) K Capital Capital, or physical capital, are
the tools we make to help us make other stuff.
These tools make us much more productive in terms
of ability to generate output. I was watching the
history channel one day and there was a program
about lumber. It was mentioned that the tools
used to cut wood have been refined in such a way
that per tree we can get more pieces of lumber.
Basically the teeth of the saws have been made
smaller and better. This enhances the output per
worker. 4) Natural resources and Land. The
quality of land in a country contributes to
average labor productivity, but what gives a
boost is discovering more of the other natural
resources we have. This would include petroleum
and metals and stuff like that.
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5) Technology Think about personal computers
today. They really are pieces of capital. But
they are more sophisticated today and the same
size box today does now more than ever. So we
have had technological advancement. In the US
economy we have had tremendous advancement in
areas such as transportation, communications,
manufacturing and medicine.
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6) Entrepreneurship and management. You have
probably heard of the names Ford, Carnegie,
Rockefeller, Walton and Gates. These folks, and
many more like them, are called entrepreneurs and
they have started new enterprises. Their work
has often lead to improvements in the way we do
things and thus labor productivity has been
enhanced. 7) Political and legal environment.
How would you like it if you had to give me 5
bucks every day? You probably wouldnt like it.
You might even think your private property is
being taken unjustly and maybe you wouldnt
produce stuff so you wouldnt have the 5 bucks.
Governments have a role in making average labor
productivity higher by establishing rule (laws)
that are conducive to productivity. Well defined
property rights help promote productivity because
we know what we can do with the resources we
control.
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So, up to know we have considered factors that
have increased our ability to make output that
have contributed to economic growth. Next lets
look at how we might go about enhancing these
ideas. Increasing Human Capital Many governments
provide education free to the public as consumer
with the idea that the increased knowledge gained
will enhance productivity. Governments can also
make the tax environment less burdensome when
folks engage in activity that enhances worker
knowledge.
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Saving and Investment For now lets broadly
define saving as our income not consumed. We saw
in a previous section on production possibilities
that as we consume less - save more - we can
devote more to the accumulation of capital goods.
This accumulation of capital goods is called
investment and depends on saving. Countries that
tend to save more have greater capital
accumulation and higher RGDP levels. Even if a
country does not save much it can accumulate more
capital goods if foreigners bring their savings
there. This foreign interaction could take two
forms foreign direct investment or foreign
portfolio investment.
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Foreign direct investment is when a company owns
and operates a segment of its business in another
country. Ford Motor Company assembly lines in
other countries is an example of this, or a
Mercedes Benz assembly line in the US. Foreign
portfolio investment is foreign money helping a
business but operated by domestic residents. So,
whether we save or have foreigners contribute,
more investment in capital goods means the
economy can grow. Diminishing returns You and I
know that when you give people tools (capital
goods) to work with their output grows because
tools help us do things quicker and better. But,
given all other factors, the increases in output
slow down as you continue to increase capital
because at some point we just cant use all the
tools all the time. So, more tools means more
output, but at diminishing rates.
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The catch-up effect analogy first - people who
have never played golf before will probably start
out shooting about a 60 for nine holes, whereas
folks who have played for some time will shoot
around 45 or better. Now if both types of
players play about the same amount of golf the
60s shooter will lower scores quicker than the
45 shooter. The logic is the 60s shooter has
beginners stuff to learn and the finer points of
the game, while the 45 shooter only has to work
on the finer points. The beginner stuff is easy
and so the 60 shooter can lower the score by 10
shots quickly, whereas the finer points are hard
to get and thus to lower a 45 to 35 is a lot
harder. So, when we are relatively new, the
scores lower more quickly that when we are a
veteran. The relatively new players experience
the catch-up effect (terminology here - not to
be confused with the spot on your shirt after
eating a burger that is the ketchup effect).
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Counties with low rates of capital usage will
experience the catch-up effect early on as they
employ more capital, but eventually diminishing
returns will set in. Similarly the rate of
growth of RGDP will be high at first but then the
rate of growth will slow. The US is often
criticized for having low rates of growth
compared to other countries. But, remember we
are the biggest economy in the world. Exaggerated
example US economy grows from 13 trillion to 14
trillion a 7.7 gain in GDP. Mexico grows from
2 trillion to 3 trillion a 50 gain. When you
just look at percent US looks weak.
16
Population Growth and some guy named
Malthus Malthus, a man dead for many years now,
thought the human race was doomed to a
subsistence level of output. To Malthus the
population would grow faster than output and we
would end up with less and less stuff per person.
Eventually this would mean we would all be
miserable (imagine Tiny Tims family before
Scrooge has a change of heart). I like to think
that Malthus thought the human race was like a
population of deer. Eventually the size of the
population gets so large that there is not enough
food to go around and thus the population dies
off. The thing Malthus did not foresee was the
advancement of technology and the use of capital
goods. Technology and capital goods overcome
population crowding and provide us with increased
living standards. Was Malthus just ahead of his
time (but basically right?) or will technology
and capital continue to keep us ahead of the doom
and gloom? Only time will tell, but I think
Malthus will always be wrong. But, I thank him
for thinking. We must always be vigilant on
these matters!