Growth and Developing

Lecture 1 - M&S 3-4

3-2
Key Concepts
GDP Growth
Total output
Output per capita
Elements of Growth
Labor
Capital
Total Factor Productivity
3-3
The Importance of Economic Growth
"No society can surely be flourishing and
happy, of which the far greater part of the
members are poor and miserable."
--Adam Smith
3-4
GDP Growth
An increase over time in the quantity of goods
and services produced by an economy
Rate of growth
Real GDP: adjusts for inflation
Real GDP per capita: adjusts for size of
population
3-5
Aggregate Real GDP
3-6
Real per capital GDP
3-7
Aggregate Real GDP
3-8
Real per capita GDP
3-9
Importance of Growth
Growing population
Life expectancy
Improving standards of living
Poverty reduction
3-10
-6%
-4%
-2%
0%
2%
4%
6%
0 5,000 10,000 15,000 20,000 25,000
GDP per capita, US $$
G
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,

1
9
8
0

2
0
0
0

(
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)

Growth rate and Level of GDP
3-11
-6%
-4%
-2%
0%
2%
4%
6%
-5000 5000 15000 25000
GDP per capita, US $$
G
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1
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2
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0

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China
India
Points are weighted by size of population in 1980
Growth rate and Level of GDP
3-12
Inequality and Growth
0.20
0.30
0.40
0.50
0.60
0.70
0.80
-10 -5 0 5 10 15 20
Growth Rate
M
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e

I
n
e
q
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a
l
i
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y

3-13
Which enhances welfare?
Eliminate business cycle movements
Enhance growth rate
3-14
1999 GDP per
capita
(US = $30600)

Years to attain US 1999 level

Actual
growth
rate
(1990-99)

1% growth

3% growth

6% growth

9% growth

Germany
$25350

20 years

7 years

4 years

3 years

1.5%

UK

$22640

32 years

11 years

6 years

4 years

2.1%

Brazil

$4420

196 years

66 years

34 years

23 years

1.7%

China

$780

370 years

145 years

64 years

44 years

9.8%

Ethiopia

$100

577 years

194 years

99 years

67 years

2.2%

Compounding is a wonderful thing
3-15
Real GDP per capita, Top Ten
PPP US $
$0
$5,000
$10,000
$15,000
$20,000
$25,000
$30,000
$35,000
$40,000
N
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Source: OECD, Authors calculation
3-16
Real GDP per capita, Bottom Ten
PPP US $
Source: OECD, Authors calculation
$0
$100
$200
$300
$400
$500
$600
$700
$800
$900
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3-17
Analysis of Growth
Capital
(buildings,
infrastructure
and
machines)
Total Factor
Productivity
(technological
knowledge and
efficiency)
Output (GDP)
Labor
(Hours worked, number
of workers)
3-18
GDP per capita
GDP per capita =
GDP
Population
GDP Hours Number Employed Labor Force
Hours Number Employed Labor Force Population
=
Labor Productivity
Average Hours Worked
Employment Rate
Labor Force
Participation Rate
3-19
GDP per capita
Labor productivity
Average hours worked
Employment rate = 1 Unemployment Rate
Labor force participation rate
3-20
Role of Inputs
More inputs means more output
Diminishing returns
1 worker = $10 in output
2 workers = $18 in output
3 workers = $24 in output
Marginal return is
$8 in output
Marginal return is
$6 in output
3-21
Production Function
Output = TFP Capital Stock
a
Labor Hours
(1-a)
Real GDP
Total Factor Productivity
A parameter
(a number, 0 < a < 1)
3-22
Cobb-Douglas example
0
100
200
300
400
500
600
700
800
900
1000
0 500 1000 1500 2000 2500
R
e
a
l

G
D
P

Hours worked
TFP = 1
Capital = 500
a=0.6
3-23
0
100
200
300
400
500
600
700
800
900
1000
0 500 1000 1500 2000 2500
Hours Worked
R
e
a
l

G
D
P

0.6 0.4
(500) (Labor Hours) Output =
3-24
0
200
400
600
800
1000
1200
1400
1600
1800
0 500 1000 1500 2000 2500
Capital Stock
Output
0.6 0.4
(Capital Stock) (1000) Output =
3-25
Implications for labor productivity
Output = TFP Capital Stock
a
Labor Hours
(1-a)
Labor Productivity
a
GDP Capital
TFP
Labor Hours Labor Hours
| |
=
|
\ .
3-26
Changes in Labor Productivity
Total Factor Productivity
Capital per Labor Hour
3-27
Capital Stock per labor hour
L
a
b
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P
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t
i
v
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500 1000
8
12
Labor Productivity = TFP (Capital Stock/Labor Hours)
a
3-28
Output Growth
% GDP per capita = % Labor Productivity A A
and
% Labor Productivity = % TFP %
Capital
a
Labor Hour
| |
A A + A
|
\ .
3-29
Capital Stock per Labor Hour
Labor Productivity
k
1

y
1

y
2

Output/Labor Hour = TFP (Capital/Labor Hour)
a
Increase in TFP
3-30
Growth in Output
Increase in labor supply
May have no impact on GDP per capita
Not sustainable
Increase in capital stock
Must increase at faster rate than labor
Increase in TFP
No diminishing returns in this framework
3-31
Growth accounting for Japan, Germany, the UK, and the United
States, 19131950.
3-32
Growth accounting for Japan, Germany, the UK, and the United
States, 19501973.
3-33
Growth accounting for Japan, Germany, the UK, and the United
States, 19731992.
3-34
Europe and Asia


Total Output:

Of Which





Capital

Labor

TFP

Golden Age 1950-73









France

5.0%

1.6%

0.3%

3.1%

UK

3.0%

1.6%

0.2%

1.2%

W. Germany

6.0%

2.2%

0.5%

3.3%

Asian Miracle 1960-94









China

6.8%

2.3%

1.9%

2.6%

Hong Kong

7.3%

2.8%

2.1%

2.4%

Indonesia

5.6%

2.9%

1.9%

0.8%

Korea

8.3%

4.3%

2.5%

1.5%

Thailand

7.5%

3.7%

2.0%

1.8%

Singapore

8.5%

4.4%

2.2%

1.5%

Europe relied on capital and TFP
Asian countries have relied on capital
3-35
Growth Accounting
Japan
Capital growth important through out
Labor, TFP important 50 73
US
TFP important until 73
Labor important after 73
UK and Germany rely less on labor


3-36
Growth Accounting
Asian Tigers, 1966 - 1990
3-37
Growth accounting in emerging markets, 19601994.
3-38
Summary
Importance of Growth
Sources of Growth
GDP per capita
Hourly productivity
Number of hours worked
Productivity
Capital Accumulation
TFP
Growth Accounting
3-39
Key Concepts
Definition of Capital and Investment
Decreasing Marginal Return
Convergence in Rates of Growth
The Steady State
The Golden Rule
3-40
Growth Transitions
Labor Growth
Capital Growth
TFP Growth
3-41
Labor Hours
R
e
a
l

G
D
P


(
b
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l
l
i
o
n
s

o
f

1
9
9
6

$
)

500 1000
6
12
15
An increase in the
quantity of labor
increases Real
GDP
1500
But growth
rate
decreases
as labor
increases
Decreasing marginal product
3-42
Quantity of Capital
R
e
a
l

G
D
P


(
b
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l
l
i
o
n
s

o
f

1
9
9
6

$
)

500 1000
6
12
15
An increase in the
quantity of capital
increases Real
GDP
1500
But growth
rate
decreases
as capital
increases
Decreasing marginal product
3-43
Capital (K)
Total value of the machines and buildings used to produce output
Capital depreciates (wears out)
Assume constant rate of depreciation, d
Assume depreciation is fraction of capital stock, d*K
3-44
Diminishing Marginal Return
Growth will be fast when level of capital is low
Growth slows down as capital accumulates
Eventually, firms wont add new capital firms
only replace depreciated capital
Economy reaches a Steady State
3-45
Optimal Investment
Value of new capital is
(Marginal Product) x (Price of Output)
Suppose 6 x $2 = $12
Cost of new capital
Denoted by r
Suppose r = $12
Purchase new capital if
MP x Price of output= r
Price of Output MP r =
3-46
Decreasing Marginal Product of
Capital
M
a
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g
i
n
a
l

p
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o
d
u
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c
a
p
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t
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Capital Stock
Cost of Capital, r/p
Marginal Product = r/p
Marginal Product
3-47
Capital
(billions of 1996 $)
R
e
a
l

G
D
P


(
b
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l
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s

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f

1
9
9
6

$
)

$80 $160
$6
$12
$15
$240
Firms will cease to add capital when marginal
return is less than the marginal cost
Stop here if r > 3.75%
3-48
Comments on interest rates (R)
What determines the interest rate?
Interaction of savings and investment
Effect of changes in the interest rate
High interest rate economy is a low capital
economy
Low interest rate economy is a high capital
economy
3-49
Determination of R
I
n
t
e
r
e
s
t

R
a
t
e

Output
Savings
Investment
R
0

I
0

3-50
Capital
(billions of 1996 $)
R
e
a
l

G
D
P


(
b
i
l
l
i
o
n
s

o
f

1
9
9
6

$
)

$80 $160
$6
$12
$20
$240
Effect of TFP growth
3-51
Determination of R
I
n
t
e
r
e
s
t

R
a
t
e

Output
Savings
Investment
R
0

I
0

R
1

I
1

3-52
Steady State
Output
Investment
Capital Stock
R
e
a
l

G
D
P

Investment (20% of GDP)
C + G + X - M
3-53
The Asian Miracle
Why did Asian economies grow so fast after
1950?
Can this experience be repeated elsewhere?
3-54
Growth Accounting
Asian Tigers, 1966 - 1990
3-55
Growth accounting in emerging markets, 19601994.
3-56
Central Provident Fund Contributions
% of Wages
0
10
20
30
40
50
1982 1984 1986 1988 1990
Savings in Singapore
Employees
Employers
3-57
Does source of growth matter?
Growth means high standard of living
Growth through capital accumulation
Eventually dissipates
Comes at a cost (low consumption in previous
generations)
Transition to TFP-induced growth?
3-58
Summary
Marginal Product of Capital
Implications of decreasing MPK
Role in determining Steady State
Steady State Investment
Investment = Depreciation
Growth can no longer be achieved through investment
Dependence on investment rate and savings rate
Golden Rule
The Asian Tigers