BackEconomic Growth, Technological Change, and Creative Destruction: Principles of Macroeconomics
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Economic Growth and Technological Change
Introduction to Economic Growth
Economic growth refers to the sustained increase in a country's output of goods and services, typically measured by real GDP per capita. Understanding the sources and effects of economic growth is central to macroeconomics, as it determines long-term improvements in living standards.
Economic growth is not inevitable; history has seen periods of stagnation.
Some countries achieve rapid increases in output per capita, while others lag behind.
The model of economic growth helps explain these differences.
Growth Over Time and Around the World
Significant worldwide economic growth has occurred only in the last two centuries, following millennia of little change in living standards.
For most of human history, the standard of living remained unchanged.
Modern economic growth began with the Industrial Revolution.
Annual Growth Rates for the World Economy
Growth rates in real GDP per capita have varied over time, with notable increases after the Industrial Revolution.
Period | Annual Growth Rate (%) |
|---|---|
1 C.E. - 1000 | 0% |
1000-1820 | 0.05% |
1820-1870 | 0.62% |
1870-1950 | 1.01% |
1950-2000 | 2.20% |
2000-2021 | 1.61% |
Even small differences in growth rates have large effects over time.
For example, a 1.61% growth rate over 55 years leads to a 122% increase in GDP per capita, while a 2.2% rate leads to a 197% increase.
The Industrial Revolution and Economic Growth
Origins of Modern Economic Growth
The Industrial Revolution marked the beginning of sustained economic growth, driven by technological innovation and changes in production methods.
Industrial Revolution: Application of mechanical power to production, starting in England around 1750.
Before this, production relied on human and animal labor.
Mechanical power enabled countries like England, the United States, France, and Germany to experience rapid economic growth.
Why Did the Industrial Revolution Begin in England?
Institutional changes, such as the Glorious Revolution of 1688, played a key role in England's economic transformation.
Parliament gained control over taxation and government, reducing arbitrary power of the king.
The court system became independent, protecting property rights and encouraging investment.
These changes incentivized entrepreneurs to invest in new technologies and production methods.
Effects of Growth Rates on Living Standards
Comparing Countries Over Time
Small differences in growth rates can lead to significant divergence in living standards between countries over decades.
Country | Real GDP per Capita (1960, 2017 USD) | Growth in Real GDP per Capita (1960-2019, %) |
|---|---|---|
United States | 15,409 | 54409 |
South Korea | 6472 | --- |
Other country | --- | --- |
Additional info: Table entries inferred due to incomplete data.
Countries with slow growth fail to raise living standards, affecting health, education, and poverty rates.
High infant mortality and low life expectancy are common in slow-growing economies.
Determinants of Economic Growth
Labor Productivity
Labor productivity, the amount of goods and services produced per worker or per hour worked, is a key driver of economic growth.
Two main factors affect labor productivity:
Quantity of capital per hour worked
Level of technology
Technological Change
Technological change refers to improvements in the ability to produce output with a given set of inputs.
Sources of technological change include:
New machinery and equipment (e.g., steam engine, electric generators)
Increases in human capital (education and training)
Better organization and management of production (e.g., just-in-time systems)
Per-Worker Production Function
The per-worker production function shows the relationship between real GDP per hour worked and capital per hour worked, holding technology constant.
Initial increases in capital are highly effective at raising output.
Subsequent increases result in diminishing returns—smaller incremental gains in output.
Equation:
Where is output, is technology, is capital, and is labor.
Role of Technological Change
Technological change can overcome diminishing returns to capital and is essential for long-run growth.
In countries with low capital, increases in capital are effective.
In high-capital countries, technological change is more important for growth.
Economic Growth Models
Solow Growth Model
The Solow model explains long-run growth in real GDP per capita, focusing on capital accumulation and technological change.
Labor productivity increases with capital and technology.
Technological change is treated as exogenous (outside the model).
New Growth Theory
New growth theory emphasizes the role of economic incentives in driving technological change and knowledge capital accumulation.
Knowledge capital is nonrival and nonexcludable, leading to increasing returns at the economy level.
Private firms may underinvest in knowledge capital due to spillovers.
Government policies (patents, R&D subsidies, education) can encourage knowledge capital creation.
Creative Destruction and Entrepreneurship
Schumpeter's Model
Joseph Schumpeter argued that entrepreneurs drive economic growth through creative destruction, replacing old products and processes with new ones.
Entrepreneurs introduce innovations that disrupt existing markets.
Creative destruction is essential for long-term growth.
Growth in the United States
Historical Trends
The United States has experienced varying growth rates, with significant increases during periods of technological innovation and government investment in R&D.
Growth rates were moderate before 1900, increased in the 20th century, and slowed after the mid-1970s.
Recent debates focus on whether slow growth is due to measurement issues or structural changes in the economy.
Role of Information Technology
Information technology has driven productivity improvements since the mid-1990s, though its long-term impact is debated.
Faster data processing and better communication have increased convenience and access to information.
Some economists argue that productivity gains from IT may be overstated or limited.
Catch-Up and Convergence
Economic Growth Model Predictions
The growth model predicts that poorer countries should grow faster than richer ones, leading to convergence in living standards.
Catch-up occurs when countries with lower initial GDP per capita experience higher growth rates.
Evidence of catch-up is mixed; some countries converge, others do not.
Barriers to Catch-Up
Several factors can prevent low-income countries from catching up:
Weak institutions and rule of law
Political instability and revolutions
Poor public education and health
Low rates of saving and investment
Globalization and Economic Growth
Role of Globalization
Globalization, the process of increasing international trade and investment, has helped many countries escape low growth.
Foreign direct investment (FDI) and portfolio investment provide capital and technology.
Countries embracing globalization tend to grow faster.
Policies to Promote Economic Growth
Key Growth Policies
Protecting property rights and rule of law
Investing in health and education
Encouraging technological change (e.g., R&D subsidies, FDI)
Promoting savings and investment
Review Questions and Applications
Sample Questions
True or False: Moving from point A to point B on the production function shows the effect of technological change. Answer: False, because technology is assumed constant along the per-worker production function.
True or False: To move from point B to point C, the economy must increase both capital per hour worked and experience technological change. Answer: True.
Best measure of standard of living: Real GDP per capita.
Example of foreign direct investment: An American company builds a hub in China.
Additional info: Some tables and examples have been expanded for clarity and completeness.
