Economic Growth, Productivity, and Living Standards

1
Economic Growth, Productivity, and Living
Standards
2
Introduction

• Which would you rather be? An ordinary,
  middleclass American living today, or the richest
  person in America at the time of George
  Washington?

3
Real GDP per Person In Selected Countries,
1870-2003 (in 2000 U.S. Dollars)
Annual change 1950-2003
Annual change 1870-2003
Country
1870
1913
1950
1979
2003
Australia 5,512 7,236 9,369 17,670 28,312 1.2 2.1
Canada 2,328 5,509 8,906 19,882 29,201 1.9 2.3
France 2,291 4,484 6,164 18,138 26,176 1.8 2.8 Ge
rmany 1,152 2,218 4,785 17,222 25,271 2.3 3.2 Ita
ly 2,852 4,018 5,128 16,912 25,458 1.7 3.1 Japan
931 1,763 2,141 16,329 26,636 2.6 4.9 United
Kingdom 3,892 5,976 8,709 16,557 26,852 1.5 2.1 U
nited States 2,887 6,852 12,110 22,835 35,488 1.9
2.0
4
Real GDP per Person in Five Industrialized
Countries, 1870 - 2003
5
The Remarkable Rise in Living Standards The
Record

• A Caveat
• Historical estimates are less precise
• Comparing economic output over a century cannot
  account for new goods and services

6
The Remarkable Rise in Living Standards The
Record

• Observation
• The variety, quality, and quantity of goods and
  services increased enormously during the 19th and
  20th centuries, as reflected in real per capita
  GDP.

7
Real GDP per Person In Selected Countries,
1870-2000 (in 1995 U.S. Dollars)
Annual change 1950-2000
Annual change 1870-2000
Country
1870
1913
1950
1979
2000
Australia 5,626 7,385 9,561 18,033 24,708 1.1 1.9
Canada 2,447 5,791 9,362 20,899 26,604 1.8 2.1
France 2,249 4,401 6,049 17,801 22,447 1.8 2.6 Ge
rmany 1,205 2,320 5,005 18,014 23,247 2.3 3.1 Ita
ly 2,248 3,167 4,042 13,331 21,930 1.8 3.4 Japan
963 1,825 2,216 16,899 24,772 2.5 4.8 United
Kingdom 3,500 5,374 7,832 14,889 21,142 1.4 2.0 U
nited States 2,843 6,745 11,921 22,480 32,629 1.9
2.0

• Observations
• 1870 Australia had the highest per capital real
  GDP and Japan the lowest
• 2000 real per capita GDP in Japan exceeded
  Australia
• Note the difference in the growth rate of 1.1
  for Australia and 2.5 for Japan

8
Real GDP per Person In Selected Countries,
1870-2003 (in 2000 U.S. Dollars)
Annual change 1950-2003
Annual change 1870-2003
Country
1870
1913
1950
1979
2003
Australia 5,512 7,236 9,369 17,670 28,312 1.2 2.1
Canada 2,328 5,509 8,906 19,882 29,201 1.9 2.3
France 2,291 4,484 6,164 18,138 26,176 1.8 2.8 Ge
rmany 1,152 2,218 4,785 17,222 25,271 2.3 3.2 Ita
ly 2,852 4,018 5,128 16,912 25,458 1.7 3.1 Japan
931 1,763 2,141 16,329 26,636 2.6 4.9 United
Kingdom 3,892 5,976 8,709 16,557 26,852 1.5 2.1 U
nited States 2,887 6,852 12,110 22,835 35,488 1.9
2.0

• Observations
• 2000 Real Per Capital GDP in Japan was greater
  than Australia
• 2003 Australias Real Per Capita GDP was greater
  than Japan
• Small changes in growth rates make a big
  difference

9
Why Small Differences in Growth Rates Matter

• Compound Interest
• Suppose
• In 1800 10 deposited _at_ 4 interest
• In 2005 the account is worth 25,507.50
• 10 x (1.04)205 31,033.77

10
Why Small Differences in Growth Rates Matter

• Compound Interest
• The payment of interest not only on the original
  deposit but on all previously accumulated interest

11
Why Small Differences in Growth Rates Matter
Interest rate () Value of 10 after 205 years
2 579.48 4 31,033.77 6 1,540,644.29

• Observations
• A small sum compounded over long periods can
  greatly increase in value
• Small differences in interest have a very large
  impact on value

12
Why Small Differences in Growth Rates Matter

• Compound Interest
• Economic growth rates are similar to compound
  interest rates.
• Government policies that affect the long-term
  growth rate by a small amount will have a major
  economic impact.

13
Why Nations Become Rich The Crucial Role of
Average Labor Productivity

• Question
• What determines a nations economic growth rate?
• Some definitions
• Y real GDP
• N number of employed workers
• POP total population

14
Why Nations Become Rich The Crucial Role of
Average Labor Productivity

• Real GDP Per Person

15
Why Nations Become Rich The Crucial Role of
Average Labor Productivity

• Real GDP Per Person

• Observations
• Real output/person depends on
• How much each worker can produce.
• The percent of the population that is working.

16
Real GDP per Person and Average Labor
Productivity in the U.S., 1960 - 2004
17
Share of the U.S. Population Employed, 1960 - 2004
18
Why Nations Become Rich The Crucial Role of
Average Labor Productivity

• Question
• What determines a nations economic growth rate?
• In the long run, increases in output per person
  arise primarily from increases in average labor
  productivity.

19
The Determinants of Average Labor Productivity

• Human Capital
• The talents, education, training, and skills of
  workers

20
The Determinants of Average Labor Productivity

• Example
• Lucy and Ethel on the assembly line
• Lucy and Ethel wrap and box chocolate candies.
• Lucy (a novice) wraps 100 candies/hr or
  4,000/week
• Ethel (received on-the-job training) wraps 300/hr
  or 12,000/week
• Average labor productivity/week 16,000/2
  8,000/week or 16,000/80 hrs 200 candies/hr
• Ethel (with training) is more productive than Lucy

21
The Determinants of Average Labor Productivity

• Physical Capital
• Worker productivity depends not only on their
  skills (human capital) but on the tools (physical
  capital) they have to work with.

22
The Determinants of Average Labor Productivity

• Example
• Lucy and Ethel get automated
• Candy Co buys a candy-wrapping machine operated
  by one worker
• An untrained worker using the machine can wrap
  500 candies/hr
• Lucy uses the machine and Ethel wraps by hand

23
The Determinants of Average Labor Productivity

• Example
• Lucy and Ethel get automated
• Lucys weekly output (40 hrs x 500) 20,000
  candies
• Ethels weekly output (40 hrs x 300) 12,000
  candies
• Total output 32,000 candies/week or average
  labor productivity 16,000 candies/week or
• 32,000/80 hrs. 400 candies/hr.
• Double the average productivity without the
  machine

24
Capital, Output, and Productivity in the
Candy-Wrapping Factory
(1) Number of machines (capital)
(2) Total number of candies wrapped each week
(output)
(3) Total hours worked per week
(4) Candies wrapped per hour worked
(productivity)
0 16,000 80 200 1 32,000 80 400 2 40,000 80 500
3 40,000 80 500

• Observations
• For a given number of workers, adding capital
  will generally increase output and average labor
  productivity
• The more capital that is already in place, the
  smaller the benefits of adding extra capital

25
The Determinants of Average Labor Productivity

• Diminishing Returns to Capital
• If the amount of labor and other inputs employed
  is held constant, then the greater the amount of
  capital already in use, the less an additional
  unit of capital adds to production.

26
The Determinants of Average Labor Productivity

• Physical Capital
• Public policy designed to stimulate growth should
  consider that
• Increasing the amount of capital available to the
  workforce will tend to increase output and
  average labor productivity.
• The degree to which productivity can be increased
  by an expanding stock of capital is limited.

27
Average Labor Productivity and Capital per Worker
in 15 Countries, 1990
28
The Determinants of Average Labor Productivity

• Land and Other Natural Resources
• Generally, an abundance of natural resources
  increases the productivity of workers.
• Resources can be obtained through international
  markets.

29
The Determinants of Average Labor Productivity

• Technology
• New technologies are the single most important
  source of productivity improvement.
• A new technology will expand the productivity in
  many sectors by stimulating greater
  specialization.

30
The Determinants of Average Labor Productivity

• Economic Naturalist
• Why has U.S. labor productivity grown so rapidly
  since 1995?

31
The Determinants of Average Labor Productivity

• Entrepreneurship and Management
• Entrepreneurs
• People who create new economic enterprises

32
The Determinants of Average Labor Productivity

• Entrepreneurship and Management
• Factors influencing entrepreneurship
• Taxation
• Regulation
• Social Customs

33
The Determinants of Average Labor Productivity

• Entrepreneurship and Management
• Management
• Influence productivity by implementing more
  efficient methods of production.

34
The Determinants of Average Labor Productivity

• The Political and Legal Environment
• Establish
• Well-defined property rights
• Maintain political stability
• Promote free and open exchange of ideas

35
The Determinants of Average Labor Productivity

• Economic Naturalist
• Why did communism fail?
• Output per person in the Soviet Union was
  probably less than one-seventh the U.S. rate.
• The Soviet Union had
• Human capital.
• Physical capital.
• Natural resources.
• Technology.

36
The Determinants of Average Labor Productivity

• Economic Naturalist
• Why did communism fail?
• There was an absence of
• Private property rights.
• Free markets.
• Political stability.
• Modern legal framework.

37
The Costs ofEconomic Growth

• Costs of Economic Growth
• The opportunity cost of increasing the production
  of capital goods is
• Less consumer goods.
• Reduced leisure time, workers safety, and
  health.
• The cost of R D.
• The cost of education (human capital).

38
The Costs ofEconomic Growth

• What Do You Think?
• Do the benefits of economic growth exceed the
  costs?

39
Promoting Economic Growth

• Economic Naturalist
• Why do almost all countries provide free public
  education?

40
Promoting Economic Growth

• Promoting Growth
• Policies that promote saving and investment
• Policies that support research and development
• The legal and political framework

41
Promoting Economic Growth

• The Poorest Countries A Special Case?
• Improve the legal and political framework
• Corrupt legal systems create uncertainty about
  property rights
• Taxation and regulation discourages
  entrepreneurship
• Markets are not allowed to function
• Lack of political stability discourages foreign
  investment

42
Promoting Economic Growth

• The Poorest Countries A Special Case?
• Without political stability, foreign aid will not
  be effective.

43
Are There Limits to Growth?

• Limits to growth, assumes economic growth will
  take the form of what we have now.
• Limits to growth, overlooks that growth expands
  societys capacity to safeguard the environment.
• Limits to growth, underestimates the power of
  markets to deal with scarcity.

44
Are There Limits to Growth?

• What Do You Think?
• How can we address global environmental issues?

45
Are There Limits to Growth?

• Economic Naturalist
• Why is the air quality so poor in Mexico City?

46
The Relationship between Air Pollution and Real
GDP per Person
Air pollution
Real GDP per person
47
End of Chapter