Technological Change, Economic Growth, and Living Standards: A Study Guide

Technological Change, Creative Destruction, and Rising Living Standards

Introduction

Technological change and creative destruction are central to understanding how economies grow and living standards rise. The case of Blockbuster Video illustrates how technological innovation can disrupt established firms and industries.

• Creative destruction refers to the process by which new innovations replace outdated technologies and business models, leading to economic progress but also the decline of older firms.

• Example: Blockbuster's decline due to competition from Netflix and other streaming services.

Obtaining Economic Growth

Government Policy and Long-Term Growth

• Economic growth is not automatic; it depends on various factors, including government policies.

• Periods of stagnation have occurred in history, with little or no increase in output per capita.

• Key question: Why do some countries achieve rapid increases in real GDP per capita while others do not?

• Economists use economic growth models to analyze these differences.

Economic Growth Over Time and Around the World

Historical Perspective

• Most global economic growth has occurred in the last two centuries.

• For much of human history, living standards remained largely unchanged over long periods.

Average Annual Growth Rates for the World Economy

Growth Rate Data and Its Impact

• British economist Angus Maddison estimated worldwide growth rates starting from year 1 C.E.

• The Industrial Revolution led to sustained increases in real GDP per capita.

• Small differences in annual growth rates can lead to large differences in living standards over time.

• For example, a 1.61% growth rate over 50 years leads to a 122% increase in real GDP per capita, while a 2.2% rate leads to a 197% increase.

The Industrial Revolution

Origins and Effects

• The Industrial Revolution (beginning around 1750 in England) marked the start of significant economic growth, driven by the application of mechanical power to production.

• Before this, production relied mainly on human or animal power.

• Mechanical power enabled long-run economic growth in England, the United States, France, Germany, and other countries.

Why Did the Industrial Revolution Begin in England?

• Nobel Laureate Douglass North argued that the Glorious Revolution of 1688 was a turning point, shifting power from the monarchy to Parliament and establishing an independent court system.

• This allowed for credible protection of property rights and wealth, incentivizing investment and entrepreneurship.

The Effects of Different Growth Rates on Living Standards

Comparative Table

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

Main Purpose: This table compares the effects of different growth rates on living standards over time.

• Small differences in growth rates can lead to large differences in living standards over decades.

The Problem with Slow Economic Growth

• Countries with slow growth fail to raise living standards, affecting not just luxury goods but also health and life expectancy.

• High-income countries have much lower infant mortality rates than low-income countries.

• Poor growth can lead to higher poverty, lower life expectancy, and higher infant mortality.

The Variation in Per Capita Income Around the World

• Economists distinguish between high-income (developed) and developing countries.

• Some countries, like Singapore, South Korea, and Taiwan, have transitioned to newly industrializing countries.

• Real GDP per capita varies widely, even after adjusting for cost-of-living differences.

Is Income All That Matters?

• While income is important, other factors like health, education, and civil liberties also contribute to living standards.

• Increases in technology and knowledge can improve living standards even without significant income growth.

• However, there are limits to improvements if income remains stagnant.

What Determines How Fast Economies Grow?

Economic Growth Models and Labor Productivity

• An economic growth model explains long-run growth in real GDP per capita.

• Labor productivity is the quantity of goods and services produced by one worker or per hour worked.

• Two main factors affect labor productivity:

  1. The quantity of capital per hour worked

  2. The level of technology

• Technological change is defined as a positive or negative change in a firm's ability to produce output with a given set of inputs.

Three Main Sources of Technological Change

1. Better machinery and equipment: Innovations such as the steam engine, machine tools, electric generators, and computers.

2. Increases in human capital: Human capital is the accumulated knowledge and skills from education, training, and experience.

3. Better means of organizing and managing production: For example, the just-in-time system developed by Toyota.

The Per-Worker Production Function

Understanding the Relationship

• The per-worker production function shows the relationship between real GDP per hour worked and capital per hour worked, holding technology constant.

• The first units of capital are most effective, but subsequent increases lead to diminishing returns.

Formula:

$Y = A imes F(K, L)$

Where $Y$ is output, $A$ is technology, $K$ is capital, and $L$ is labor.

• Example: Adding a second oven to a pizza shop increases productivity, but adding a 20th oven does little if there are only 10 workers.

Technological Change Increases Output per Hour Worked

• In countries with low capital, increases in capital are very effective at raising real GDP per capita.

• In countries with high capital, technological change is more effective for increasing output per hour.

• Technological change is not subject to diminishing returns in the same way as capital.

• Long-run increases in living standards require ongoing technological change.

What Explains the Economic Failure of the Soviet Union?

• The Soviet Union, a centrally planned economy, focused on increasing capital stock but neglected technological innovation and competition.

• Lack of incentives for innovation led to slowing growth rates.

New Growth Theory

• Developed by Paul Romer, this theory emphasizes that technological change is driven by economic incentives and the market system.

• Robert Solow's earlier model treated technological change as exogenous (outside the model).

Knowledge Capital

• Knowledge capital is a key determinant of economic growth, resulting from research and development (R&D).

• Physical capital is rival and excludable (private good), leading to diminishing returns.

• Knowledge capital is nonrival and nonexcludable (public good), leading to increasing returns at the economy level.

Government's Role in Knowledge Capital Generation

• Public goods like knowledge capital can lead to free riding, where firms benefit from others' R&D without paying for it.

• Government policies can address this by:

  • Protecting intellectual property (patents, copyrights)

  • Subsidizing research and development

  • Subsidizing education

Protecting Intellectual Property

• Patents: Exclusive legal right to produce a product for 20 years from the application date.

• Copyrights: Exclusive right for creative works, lasting the creator's lifetime plus 70 years.

Subsidizing R&D and Education

• Governments may fund research directly or provide tax incentives for R&D.

• Subsidizing education ensures a technically skilled workforce for innovation.

Joseph Schumpeter and Creative Destruction

• Schumpeter emphasized the role of entrepreneurs in economic growth through creative destruction.

• New products and processes replace old ones, driving progress but also causing some firms to fail.

• Example: The automobile replaced the horse-drawn carriage industry.

Economic Growth in the United States

• The U.S. experience shows how capital accumulation and technological change drive growth.

• Growth rates were modest before 1900, then increased with investment in R&D.

• Growth slowed in the mid-1970s but picked up in the mid-1990s.

Is the United States Headed for a Long Period of Slow Growth?

• There is debate among economists about future productivity growth:

  • Optimistic view: Productivity is harder to measure, but long-run growth will continue.

  • Pessimistic view: Productivity growth has slowed since the 1970s, with only brief improvement from information technology.

Measurement Issues

• Service output is harder to measure than goods output.

• Improvements in convenience and quality may not be reflected in GDP statistics.

The Role of Information Technology

• Technological advances (computers, internet, AI) have driven productivity improvements.

• Some argue that GDP growth understates improvements in living standards due to technology.

Secular Stagnation or Return to Faster Growth?

• Some economists predict low growth due to slowing population growth, less need for capital, and lower capital prices.

• Others argue that investment will rebound and growth will resume.

Why Isn't the Whole World Rich?

• The economic growth model predicts that poor countries should grow faster than rich countries due to higher returns on capital and access to existing technologies.

The Catch-Up Effect

• If poorer countries grow faster, they will "catch up" or converge with richer countries.

• However, not all countries have experienced catch-up, indicating other factors are at play.

Why Don't More Low-Income Countries Experience Rapid Growth?

• Key barriers include:

  • Weak institutions (lack of rule of law and property rights)

  • Wars and revolutions

  • Poor public education and health

  • Low rates of saving and investment

Weak Institutions

• Rule of law: The government's ability to enforce laws, protect property rights, and enforce contracts is essential for economic growth.

• Without secure property rights, entrepreneurs are less likely to invest and innovate.

• An independent court system is also important for enforcing contracts.

Summary Table: Factors Affecting Economic Growth

Factor	Effect on Growth
Technological Change	Increases productivity, not subject to diminishing returns
Capital Accumulation	Raises output per worker, but subject to diminishing returns
Institutions (Rule of Law, Property Rights)	Encourage investment and innovation
Education and Health	Improves human capital and productivity
Political Stability	Reduces risk, encourages investment

Key Formulas and Concepts

• Per-Worker Production Function: $Y = A imes F(K, L)$

• Growth Rate Calculation: $\text{Growth Rate} = \frac{\text{GDP}_{t} - \text{GDP}_{t-1}}{\text{GDP}_{t-1}} \times 100$

• Catch-Up Effect: Poorer countries should grow faster than richer ones, all else equal.

Conclusion

Economic growth is driven by technological change, capital accumulation, and strong institutions. While some countries have achieved rapid growth and rising living standards, others lag due to weak institutions, poor education and health, and political instability. Understanding these factors is essential for designing policies that promote long-term economic growth.