Long-Run Economic Growth: Determinants, International Comparisons, and Policy

Long-Run Economic Growth

Introduction

Long-run economic growth is a central topic in macroeconomics, as it determines the improvement of living standards and health outcomes across countries. Economic growth is closely linked to reductions in poverty and mortality, as higher GDP per capita is associated with better health and survival rates.

• Key Point: Economic growth is essential for improving health and wealth, especially in developing countries.

• Example: In 2023, 263 million cases of malaria and 597,000 deaths occurred worldwide, mostly among African children. Preventing these deaths requires economic growth.

Incomes and Growth Around the World

International Comparisons

There are vast differences in living standards and growth rates across countries. These differences are measured by GDP per capita and the average annual growth rate over time.

• Key Point: Countries differ greatly in both their current income levels and their rates of economic growth.

• Example: The United States has a high GDP per capita ($75,491 in 2024) but a moderate growth rate (1.6%), while China has a lower GDP per capita ($23,846) but a much higher growth rate (8.2%).

Country	GDP per capita, 2024	Growth rate, 1990–2024
China	$23,846	8.2%
India	$9,817	4.5%
Rwanda	$3,265	4.1%
Singapore	$132,570	3.3%
Philippines	$10,376	2.5%
Columbia	$18,504	1.9%
United States	$75,491	1.6%
Chad	$2,606	1.5%
New Zealand	$48,163	1.4%
Brazil	$19,648	1.3%
United Kingdom	$52,518	1.3%
Spain	$48,373	1.2%
Russia	$41,705	1.2%
Japan	$46,097	0.8%

Key Questions

• Why are some countries richer than others?

• Why do some countries grow quickly while others remain in poverty?

• What policies can help raise growth rates and long-run living standards?

Determinants of Productivity

Productivity

Productivity is the average quantity of goods and services produced per unit of labor input. It is the primary determinant of a country's standard of living.

• Definition: Productivity = output per worker.

• Formula: $\text{Productivity} = \frac{Y}{L}$, where $Y$ is real GDP and $L$ is the quantity of labor.

• Key Point: Higher productivity leads to higher incomes and living standards.

Physical Capital Per Worker

Physical capital refers to the stock of equipment and structures used to produce goods and services. Increasing capital per worker raises productivity.

• Definition: Physical capital ($K$) is the set of tools, machines, and buildings used in production.

• Formula: $\frac{K}{L}$ = capital per worker.

• Relationship: An increase in $\frac{K}{L}$ leads to an increase in $\frac{Y}{L}$.

• Example: More machines per worker in a factory increases output per worker.

Human Capital Per Worker

Human capital is the knowledge and skills acquired by workers through education, training, and experience. Higher human capital per worker increases productivity.

• Definition: Human capital ($H$) is the sum of workers' education, training, and experience.

• Formula: $\frac{H}{L}$ = human capital per worker.

• Relationship: An increase in $\frac{H}{L}$ leads to an increase in $\frac{Y}{L}$.

• Example: More years of schooling raise a worker's wage by about 10% per year in the U.S.

Technological Knowledge

Technological knowledge is society's understanding of the best ways to produce goods and services. Advances in technology boost productivity by enabling more output from the same resources.

• Definition: Technological knowledge includes inventions, innovations, and improvements in production processes.

• Key Point: Technological progress is not limited to electronics; it includes any advance that increases productivity.

• Example: The use of AI drones in farming or new manufacturing techniques.

Economic Growth and Public Policy

Saving and Investment

Increasing the stock of physical capital requires investment, which is funded by saving. There is a tradeoff between current consumption and future productivity.

• Key Point: Higher saving leads to more investment in capital, boosting future productivity and living standards.

• Tradeoff: Producing more capital goods means sacrificing current consumption.

Investment from Abroad

Foreign investment can help countries increase their capital stock and productivity.

• Foreign Direct Investment (FDI): Capital investment owned and operated by a foreign entity (e.g., a foreign-owned factory).

• Foreign Portfolio Investment: Capital investment financed with foreign money but operated by domestic residents.

• Role of International Organizations: The World Bank and IMF help channel foreign investment to developing countries.

Education

Government policies that promote education increase human capital and productivity. Education involves a tradeoff between present and future income.

• Key Point: Each year of schooling raises a worker's wage by about 10% in the U.S.

• Tradeoff: Time spent in school means forgoing current wages for higher future earnings.

• Policy Examples: Public schools, subsidized loans for college.

Incentives and Institutions

Institutions are the rules and norms that structure economic incentives. Strong institutions are essential for economic growth.

• Key Institutions:

  1. Property rights

  2. Honest government

  3. Political stability

  4. A dependable legal system

• Example: Countries with less corruption and better governance tend to have higher growth rates.

Top Ten Least Corrupt Countries (2024)	Top Ten Most Corrupt Countries (2022)
Denmark	South Sudan
Finland	Somalia
Singapore	Venezuela
New Zealand	Syria
Luxembourg	Yemen
Norway	Libya
Switzerland	Eritrea
Sweden	Equatorial Guinea
Netherlands	Nicaragua
Australia	Sudan

Proof That Institutions Matter

Differences in economic development can be starkly observed, such as the contrast between North and South Korea, visible even from outer space due to differences in infrastructure and economic activity.

Free Trade

Trade policies significantly affect economic growth. Outward-oriented policies promote integration with the world economy and tend to foster growth, while inward-oriented policies often hinder it.

• Inward-oriented policies: Tariffs, restrictions on foreign investment; aim to protect domestic industries but often limit growth.

• Outward-oriented policies: Elimination of trade barriers; promote growth by increasing competition and access to new technologies.

• Example: South Korea, Singapore, and Taiwan experienced rapid growth after adopting outward-oriented policies post-1960.

Research and Development (R&D)

Technological progress is the main driver of long-run increases in living standards. Knowledge is a public good, and policies that promote R&D can have widespread benefits.

• Key Point: Ideas and innovations can be shared, increasing productivity for many.

• Policy Examples:

  • Patent laws

  • Tax incentives or direct support for private sector R&D

  • Grants for basic research at universities

Active Learning: Policy Discussion

Discussion Question

Which policies are most effective at boosting growth and living standards in poor countries over the long run?

• Offer tax incentives for investment by local firms

• Offer tax incentives for investment by foreign firms

• Give cash payments for good school attendance

• Crack down on government corruption

• Restrict imports to protect domestic industries

• Allow free trade

• Give away condoms

Additional info: Policies that promote investment, education, honest government, and free trade are generally considered most effective for long-run growth.