Chapter 11: Long-Run Economic Growth – Sources and Policies

Chapter 11: Long-Run Economic Growth – Sources and Policies

11.1 Economic Growth Over Time and Around the World

Economic growth refers to the sustained increase in a country's output of goods and services, typically measured by real GDP per capita. Understanding historical and global trends in economic growth helps explain differences in living standards across countries and over time.

• Definition: Long-Run Economic Growth is the process by which rising productivity increases the average standard of living.

• Measurement: The most common measure is real GDP per capita, which adjusts total output for population and inflation.

• Historical Perspective: For most of human history, living standards changed very little. Significant growth began with the Industrial Revolution.

Formula for Economic Growth Rate:

$\text{Growth Rate} = \frac{\text{Real GDP in Current Period} - \text{Real GDP in Previous Period}}{\text{Real GDP in Previous Period}} \times 100$

• Example: If Real GDP was $65,120.40 in 2019 and $63,526 in 2020, the growth rate is:

• $\frac{63,526 - 65,120.40}{65,120.40} \times 100 = -2.44\%$

Averaging Growth Rates:

$\text{Average Annual Growth Rate} = \frac{2.4\% + 2.6\% + 1.6\%}{3} = 2.2\%$

Global Trends: Small differences in annual growth rates can lead to large differences in living standards over decades. For example, countries with similar GDP per capita in 1960 (Ghana, Mexico, Turkey) now have very different standards of living due to differing growth rates.

Country	Real GDP per Capita, 1960 (2017 USD)	Growth in Real GDP per Capita, 1960-2019 (%)	Real GDP per Capita, 2019 (2017 USD)
Ghana	$4,409	0.4%	$5,547
Mexico	$6,472	1.9%	$19,308
Turkey	$5,051	2.7%	$26,700

Additional info: Over long periods, even small differences in growth rates compound to produce large differences in income and living standards.

11.2 What Determines How Fast Economies Grow?

The economic growth model explains why growth rates differ across countries, focusing on labor productivity and its determinants.

• Labor Productivity: The amount of goods and services produced by one worker.

• Key Factors Affecting Productivity:

  1. Quantity of capital per worker (physical capital such as machinery, equipment, and infrastructure)

  2. Level of technology (knowledge, innovation, and efficiency in production)

Economic Growth Model (Production Function):

$Y = A \cdot f(L, K)$

• Y: Output (GDP)

• K: Physical capital

• L: Labor (workers)

• A: Technology (efficiency factor)

Per-Worker Production Function: Shows the relationship between output per worker and capital per worker.

• Increases in Physical Capital: More capital per worker increases output, but subject to diminishing marginal returns (each additional unit of capital adds less to output).

• Increases in Technology: Technological improvements shift the production function upward, allowing more output without diminishing returns.

Example: In a pizza shop, adding a second oven increases productivity, but adding a 20th oven when you already have 19 does little. However, a new oven that bakes pizzas faster increases productivity for all workers.

11.3 Economic Growth in the United States

Productivity growth in the United States has fluctuated over time, influenced by technological change, capital accumulation, and economic policies.

• Soviet Union vs. United States: The Soviet Union invested heavily in capital but failed to sustain growth due to lack of technological innovation and poor economic incentives.

• Economic Incentives: In market economies like the U.S., competition and profit motives drive technological change and productivity growth.

• Growth Rates: U.S. growth rates have varied, with higher rates during periods of rapid technological change (e.g., post-WWII, information age).

United States Growth Rate of Real GDP per Hour Worked:

Period	Growth Rate (%)
1800-1900	1.3
1900-1949	2.2
1950-1973	2.6
1973-1985	1.5
1986-2005	2.4
2006-2022	1.1

Additional info: Market incentives and openness to innovation are crucial for sustained economic growth.

11.4 Why Isn't the Whole World Rich?

Economic catch-up refers to the process by which poorer economies grow faster than richer ones, narrowing the income gap. However, not all low-income countries experience rapid growth.

• Catch-Up Effect: Lower-income countries can potentially grow faster by adopting existing technologies and practices from richer countries.

• Convergence: Some countries have caught up, but many developing countries have not, due to various barriers.

• Barriers to Growth:

  • Weak institutions (poor governance, lack of property rights)

  • Wars and revolutions (political instability)

  • Poor public education and health

  • Low rates of saving and investment

Example: Countries with strong institutions and investment in education and health (e.g., South Korea, Taiwan) have achieved rapid growth, while others have lagged behind.

11.5 Growth Policies

Government policies play a crucial role in fostering economic growth by creating an environment conducive to investment, innovation, and productivity improvements.

• Enhancing Property Rights and Rule of Law: Secure property rights and effective legal systems encourage investment and entrepreneurship.

• Improving Health and Education: Investments in human capital increase labor productivity and innovation.

• Promoting Technological Change: Support for research and development, innovation, and technology adoption accelerates growth.

• Promoting Saving and Investment: Policies that encourage saving and investment in physical and human capital boost long-term growth.

Summary Table: Key Growth Policies

Policy Area	Effect on Growth
Property Rights & Rule of Law	Encourages investment and entrepreneurship
Health & Education	Improves labor productivity and innovation
Technological Change	Accelerates productivity and output
Saving & Investment	Increases capital stock and future output

Additional info: Effective growth policies require stable institutions, investment in human and physical capital, and openness to innovation.