Long Run Economic Growth

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Long Run Economic Growth
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Some observations

• Income of people and revenues of government
  depends on economic growth
• Our purpose try to explain the causes of
  economic growth

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Adam Smith (1723-1790)

• Father of Economics
• Wrote a bonk entitled An Inquiry into the Nature
  and Causes of the Wealth of Nations (1776)
• A treatise on economic growth
• Its Purpose Understand the source of Britain's
  Wealth

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Wealth

• .Wealth goods and services
• .Wealth depends on
• Quantity of labor
• Productivity of labor
• Productivity depends on the division of labor
• Division of labor depends on self interest
• .Principle underlying economic relations
  invisible hand

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Invisible hand and the Market

• Market is an automatic mechanism, a system of
  negative feedbacks
• Self corrects--no one controls the market
• Market organizes economic activities based on
  voluntary cooperation

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Smiths view of Growth

• Self interest ?? saving ??investment
  ??machines??division of labor ?? productivity
  ??growth ?benefits everyone
• Key to growth saving

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Empirical Observations

• In 1870, Australia was the richest of the eight
  major economies considered in a study
• By 1996, Australia is the poorest
• Over the long term Japan experienced the highest
  growth rate, followed by Germany and Canada

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Sources of Economic Growth

• Y AF(K,N)
• Where Y output
• A productivity
• K capital stock
• N labor
• Increases in output depend on increases in inputs

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• Taking the log derivative, we get
• ?Y/Y ?A/A ?k ?k/k ?n ?N/N
• Where Y output
• ?k elasticity of capital, that is, the
  increase in output owing to a one percent
  increase in capital
• ?n elasticity of labor, the increase in
  output owing to a one percent increase in labor

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Growth Accounting

• Means identifying the contribution of
  productivity, capital, and labor
• First, identify the percent change in output,
  capital and labor
• Second, estimate the elasticities ties of capital
  and labor from historical data
• Third, calculate the contribution to growth of
  capital and labor

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• Identify the unexplained residual, which is
  attributed to productivity
• ?Y/Y ?A/A ?k ?k/k ?n ?N/N
• Hence, to identity the contribution of
  productivity
• ?A/A ?Y/Y - ?k ?k/k - ?n ?N/N

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Slow down in Productivity Growth during from
1973-1982

• Changes in the legal and human environment
  environmental and safety legislation
• Decline in innovation
• Oil price increase
• Cost of using information techology

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Solow Growth Model

• Tries to answer 3 questions
• What is the relation between living standards and
  saving rates, population growth, and technical
  progress?
• How does the rate of growth evolve over time?
• Do economic forces exist that will allow poorer
  countries to catch up with rich countries in
  terms of living standards?

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We have two sets of equations
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First Set IS

• IS
• SsY
• I ?KdK
• Where drate of depreciation
• spercent of income (output) saved
• ?KsY-dK

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Second set K/N

• ?(K/N)/(K/N) (?K/K) (?N/N)
• ?(K/N) ?K- ?N
• ?K- n
• Percentage change in the capital labor ratio
  equals the percentage change in the capital stock
  less the growth rate in the population
• multiplying the equation by K/N
• ?(K/N) ?K/N nK/N
• ?K/N ?(K/N) nK/N

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Equating the results

• ?KsY-dK
• ?K/NsY/N-dK/N
• ?K/N ?(K/N) nK/N
• Then,
• ?(K/N) nK/N sY/N-dK/N
• ?(K/N) sY/N-(d n)(K/N)

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Capital accumulation equation

• ?(K/N) sY/N-(d n)(K/N)
• Changes in capital per worker equals savings per
  capita minus capital per capita required for
  depreciation and increases in the population
• Capital widening capital needed to equip new
  workers entering the labor force
• Capital deepening saving used to increase K/N
• restating the equation
• Capital deepening per capital saving capital
  widening

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Concept of Steady state growth

• In the steady state ?(K/N) 0
• Hence,
• sY/N (d n)(K/N)
• Per capita savings equals capital used per capita
  to maintain the capital stock and provide for
  population increases

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Determinants of Long-run Living Standards

• Savings rates,
• higher savings rates implies higher living
  standards in the long run
• Problem higher savings rates in the present
  involves a tradeoff between present and future
  consumption
• Higher savings rate in the present imply lower
  level of consumption

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• Population
• Increases in the population growth mean more
  capital is needed to employ the increased
  population, reducing per capital output.
• Lower growth in population, however, means less
  total output
• Does not consider the needed of working
  population to support those retired

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• Productivity
• In Solows model productivity is exogenous
• Increases in productivity shift the production
  function
• Increases in productivity shift up the production
  function

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Problem with neoclassical growth theory

• Problem with Solows model is that it takes
  productivity as given
• Solows model also predicted that growth rates
  among nations would tend to converge, along with
  profit and wage rates.
• Wages and prices on a global scale should
  converge.
• In theory, countries tend to specialize in
  producing those commodities in which they have a
  comparative advantage.

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• Countries with an abundance of labor produce
  labor intensive goods, those countries with an
  abundance of capital produce capital intensive
  goods.
• Explain the increase growth of the east Asian
  economies during the 1990s

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• From the vantage point of the labor abundant
  country, free trade results an increase in the
  price of labor, while from the vantage point of
  the labor poor country wages tend to fall. Over
  time, given relatively free trade wage rates and
  profit rates equalize.
• The data reveals rather than converging, wage
  rates and profit rates are diverging. How do we
  explain the phenomenon?

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Endogenous Growth Theory

• Differences in wage rates and profit rates result
  form differences in growth rates.
• Differences in growth rates result form
  differences in education.

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YAK

• Where Y output
• A gt0, A is constant
• K capital stock
• Each addition unit of capital increases output by
  A units
• A is the MPK,
• Its value is unrelated to the capital stock
• It does not diminish

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Why A does not diminish

• Human capital increases proportionate to
  increases in the capital stock
• Firms engage in RD, which increases the
  knowledge base having external benefits

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• I?Kdk
• SsAK
• IS
• ?KdksAK
• ?K/KsA-d
• This says the rate of growth in capital equals
  the savings rate times the MPK minus depreciation

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Implications

• Growth depends on
• Savings rate
• The growth of A, which depends on education and
  RD

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Questions

• Discuss an increase in the savings rate in the
  context of the Solow and the Endogenous Growth
  model
• What does the Solow model imply for a country
  trying to increase its growth rate? Its per
  capita income?
• What did the endogenous growth theory try to
  explain?

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• Assume for the moment that you are finance
  minister for Myanmar. What policies would you
  advocate and why to enhance economic growth?
  Justify your answer in the context of the
  different growth models.
• Explain the increased growth of the East Asian
  economies (The Asian miracle) during the 1990s.
  The slowdown in productivity in the US during the
  1970s.