Saving, Capital Accumulation, and Output

Chapter 11: Saving, Capital Accumulation, and Output

Chapter 11
Q:Does the saving rate affect growth?
A: If the production function exhibits decreasing returns to capital, an
increase in the saving rate can only affect the growth rate
temporarily. In the long run, saving does not affect growth, but does
affect the level of output per worker.

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11-1 Interactions between Output and Capital

Chapter 11: Saving, Capital Accumulation, and Output

At the center of the determination of output in the

long run are two relations between output and
capital:

The amount of capital determines the amount

of output being produced.

The amount of output determines the amount

of saving and, in turn, the amount of capital
accumulated over time.

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11-1 Interactions between Output and Capital

Figure 11 - 1

Chapter 11: Saving, Capital Accumulation, and Output

Capital, Output, and

Saving/Investment

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11-1 Interactions between Output and Capital

The Effects of Capital on Output

Chapter 11: Saving, Capital Accumulation, and Output

Under constant returns to scale, we can write the relation

between output and capital per worker as follows:

Y
K
F
, 1
N
N

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11-1 Interactions between Output and Capital

The Effects of Capital on Output

Chapter 11: Saving, Capital Accumulation, and Output

Since the focus here is on the role of capital accumulation,

we make the following assumptions:
The size of the population, the participation rate,
and the unemployment rate are all constant.
There is no technological progress.

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11-1 Interactions between Output and Capital

Chapter 11: Saving, Capital Accumulation, and Output

The Effects of Capital on Output

With these two assumptions, our first relation between

output and capital per worker, from the production
side, can be written as

Yt
K t
f

N
N
In words, higher capital per worker leads to higher
output per worker.

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11-1 Interactions between Output and Capital

The Effects of Output on Capital Accumulation

Chapter 11: Saving, Capital Accumulation, and Output

To derive the second relation, between output and

capital accumulation, we proceed in two steps:
1. We derive the relation between output and
investment.
2. We derive the relation between investment
and capital accumulation.

Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard

11-1 Interactions between Output and Capital

The Effects of Output on Capital Accumulation

Chapter 11: Saving, Capital Accumulation, and Output

Output and Investment

We make three assumptions to derive the relation
between output and investment:
We assume the economy is closed.

I S (T G )

We assume public saving, T G, is equal to zero.

I S
We assume that private saving is proportional to
income, so

S sY

Combining these two relations gives:

It sYt
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11-1 Interactions between Output and Capital

The Effects of Output on Capital Accumulation

Investment and Capital Accumulation

Chapter 11: Saving, Capital Accumulation, and Output

The evolution of the capital stock is given by:

t1

(1 ) K t I t

denotes the rate of depreciation

Combining the relation from output to investment,
I t s Y ,t and the relation from investment to capital
accumulation, we obtain the second important relation
we want to express, from output to capital accumulation:

t1

K t
Yt
(1 )
s
N
N

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11-1 Interactions between Output and Capital

The Effects of Output on Capital Accumulation

Investment and Capital Accumulation

Chapter 11: Saving, Capital Accumulation, and Output

Output and Capital per Worker:

K

t1

K t
Yt
(1 )
s
N
N

Rearranging terms in the equation above, we can get the

change in capital per worker over time:
K

t1

K t
Yt
K t

s

N
N
N

In words, the change in the capital stock per worker (left side) is
equal to saving per worker minus depreciation (right side).
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11-2 The Implications of Alternative

Saving Rates
Our two main relations are:

Chapter 11: Saving, Capital Accumulation, and Output

Yt
K t
f

N
N

t1

K t
Yt
K t

s

N
N
N

Second relation:
Output determines
capital accumulation

First relation:
Capital determines
output.

Combining the two relations, we can study the behavior of output and
capital over time.
Dynamics of Capital and Output

K t 1 K t

N
N
Change in capital
from year t to year t + 1

Kt
sf

Investment
during year t

_
_

Kt

N
Depreciation
during year t

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11-2 The Implications of Alternative

DynamicsSaving
of Capital Rates
and Output

Chapter 11: Saving, Capital Accumulation, and Output

K t 1 K t

N
N
Change in capital
from year t to year t + 1

=
=

Kt
sf

N
Investment
during year t

_
_

Kt

N
Depreciation
during year t

This relation describes what happens to capital per worker. The

change in capital per worker from this year to next year depends on
the difference between two terms:

If investment per worker exceeds depreciation per worker, the

change in capital per worker is positive: Capital per worker
increases.

If investment per worker is less than depreciation per worker,

the change in capital per worker is negative: Capital per
worker decreases.

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11-2 The Implications of Alternative

DynamicsSaving
of Capital Rates
and Output

Chapter 11: Saving, Capital Accumulation, and Output

Figure 11 - 2
Capital and Output
Dynamics
When capital and output are
low, investment exceeds
depreciation, and capital
increases. When capital and
output are high, investment is
less than depreciation, and
capital decreases.

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11-2 The Implications of Alternative

Saving
Steady-State
Capital Rates
and Output
K

t1

Chapter 11: Saving, Capital Accumulation, and Output

K t
K
K
= sf t t
N
N
N

The state in which output per worker and capital per worker are no
longer changing is called the steady state of the economy. In steady
state, the left side of the equation above equals zero, then:

K*
K *
sf

N
N
Given the steady state of capital per worker (K*/N), the steadystate value of output per worker (Y*/N), is given by the production
function:

Y*

K *
f

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Chapter 11: Saving, Capital Accumulation, and Output

Capital Accumulation and Growth in France

in the Aftermath of World War II
When WWII ended in 1945, France had suffered some
of the heaviest losses of all European countries. A
vivid picture of the destruction of capital is provided by
the numbers in Table 1.
Table 1
Railways

Roads

Proportion of the French Capital Stock Destroyed by the End of

World War II
Tracks

6% Rivers

Waterways

86%

Stations

38%

Canal Locks

11%

Engines

21%

Barges

80%

Hardware

60% Buildings

(numbers)

Cars

31%

Dwellings

1,229,000

Trucks

40%

Industrial

246,000

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11-2 The Implications of Alternative

Saving
The Saving
Rate andRates
Output

Chapter 11: Saving, Capital Accumulation, and Output

Three observations about the effects of the saving rate on the

growth rate of output per worker are:
1. The saving rate has no effect on the long run growth
rate of output per worker, which is equal to zero.
2. Nonetheless, the saving rate determines the level of
output per worker in the long run. Other things equal,
countries with a higher saving rate will achieve higher
output per worker in the long run.
3. An increase in the saving rate will lead to higher growth
of output per worker for some time, but not forever.

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11-2 The Implications of Alternative

Saving
The Saving
Rate andRates
Output

Chapter 11: Saving, Capital Accumulation, and Output

Figure 11 - 3
The Effects of Different
Saving Rates
A country with a higher
saving rate achieves a
higher steady- state level
of output per worker.

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11-2 The Implications of Alternative

Saving
The Saving
Rate andRates
Output

Chapter 11: Saving, Capital Accumulation, and Output

Figure 11 - 4
The Effects of an
Increase in the Saving
Rate on Output per
Worker
An increase in the saving rate
leads to a period of higher
growth until output reaches its
new, higher steady-state level.

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11-2 The Implications of Alternative

Saving
The Saving
Rate andRates
Output

Chapter 11: Saving, Capital Accumulation, and Output

Figure 11 - 5
The Effects of an
Increase in the Saving
Rate on Output per
Worker in an Economy
with Technological
Progress
An increase in the saving rate
leads to a period of higher
growth until output reaches a
new, higher path.

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Chapter 11: Saving, Capital Accumulation, and Output

11-2 The Implications of Alternative

Saving
The Saving
Rate andRates
Consumption
An increase in the saving rate always leads to an increase in the
level of output per worker. But output is not the same as
consumption. To see why, consider what happens for two
extreme values of the saving rate:
An economy in which the saving rate is (and has always
been) zero is an economy in which capital is equal to zero.
In this case, output is also equal to zero, and so is
consumption. A saving rate equal to zero implies zero
consumption in the long run.
Now consider an economy in which the saving rate is equal
to one: People save all their income. The level of capital,
and thus output, in this economy will be very high. But
because people save all their income, consumption is equal
to zero. A saving rate equal to one also implies zero
consumption in the long run.
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Chapter 11: Saving, Capital Accumulation, and Output

11-2 The Implications of Alternative

Saving
The Saving
Rate andRates
Consumption
The level of capital associated with the
value of the saving rate that yields the
highest level of consumption in steady
state is known as the golden-rule level
of capital.

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11-2 The Implications of Alternative

Saving
The Saving
Rate andRates
Consumption

Chapter 11: Saving, Capital Accumulation, and Output

Figure 11 - 6
The Effects of the
Saving Rate on SteadyState Consumption per
Worker
An increase in the saving rate
leads to an increase and then
to a decrease in steady-state
consumption per worker.

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Chapter 11: Saving, Capital Accumulation, and Output

Social Security, Saving, and Capital Accumulation in

the United States
One way to run a social security system is the fullyfunded system, where workers are taxed, their
contributions invested in financial assets, and when
workers retire, they receive the principal plus the interest
payments on their investments.
Another way to run a social security system is the payas-you-go system, where the taxes that workers pay
are the benefits that current retirees receive.
In anticipation of demographic changes, the Social Security
tax rate has seen increases, and contributions are now
larger than benefits, leading to the accumulation of a Social
Security trust fund.
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11-3 Getting a Sense of Magnitudes

Assume the production function is:

Chapter 11: Saving, Capital Accumulation, and Output

Output per worker is:

N
N

K
N

K
N

Output per worker, as it relates to capital per worker is:

K t

N

K t
N

Given our second relation,

Then,

t1

K t
s
N

t1

K t
K t
K t

= sf

N
N
N

K t
K
t
N
N

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11-3 Getting a Sense of Magnitudes

The Effects of the Saving Rate on Steady-State Output

Chapter 11: Saving, Capital Accumulation, and Output

Y*
K*
s
s

N
N

Steady-state output per worker is equal to the ratio of the
saving rate to the depreciation rate.
A higher saving rate and a lower depreciation rate both
lead to higher steady-state capital per worker and higher
steady-state output per worker.

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11-3 Getting a Sense of Magnitudes

The Dynamic Effects of an Increase in the Saving Rate

Chapter 11: Saving, Capital Accumulation, and Output

Figure 11 - 7
The Dynamic Effects of
an Increase in the
Saving Rate from 10% to
20% on the Level and
the Growth Rate of
Output per Worker
It takes a long time for output to
adjust to its new, higher level
after an increase in the saving
rate. Put another way, an
increase in the saving rate
leads to a long period of higher
growth.

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11-3 Getting a Sense of Magnitudes

The U.S. Saving Rate and the Golden Rule

Chapter 11: Saving, Capital Accumulation, and Output

In steady state, consumption per worker is equal to output

per worker minus depreciation per worker.

C
Y
K

N
N
N
Knowing that:

then:

K*

C
s
s


N

Y*
K*
s
s

and
N
N

s 1 s

These equations are used to derive Table 11-1 in the next slide.

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11-3 Getting a Sense of Magnitudes

The U.S. Saving Rate and the Golden Rule

Chapter 11: Saving, Capital Accumulation, and Output

Table 11-1 The Saving Rate and the Steady-State Levels of Capital,
Output, and Consumption per Worker

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11-4 Physical versus Human Capital

Chapter 11: Saving, Capital Accumulation, and Output

The set of skills of the workers in the economy is called

human capital.
An economy with many highly skilled workers is likely
to be much more productive than an economy in which
most workers cannot read or write.
The conclusions drawn about physical capital
accumulation remain valid after the introduction of
human capital in the analysis.

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11-4 Physical versus Human Capital

Chapter 11: Saving, Capital Accumulation, and Output

Extending the Production Function

When the level of output per workers depends on both

the level of physical capital per worker, K/N, and the
level of human capital per worker, H/N, the production
function may be written as:
Y
K H
f
,
N N
N
( , )

An increase in capital per worker or the average skill

of workers leads to an increase in output per worker.

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11-4 Physical versus Human Capital

Extending the Production Function

Chapter 11: Saving, Capital Accumulation, and Output

A measure of human capital may be constructed as

follows:
Suppose an economy has 100 workers, half of
them unskilled and half of them skilled. The relative
wage of skilled workers is twice that of unskilled
workers.
Then:

H
150
H [(5 0 1) (5 0 2 )] 1 5 0

1 .5
N
100

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11-4 Physical versus Human Capital

Chapter 11: Saving, Capital Accumulation, and Output

Human Capital, Physical Capital, and Output

An increase in how much society saves in the form

of human capitalthrough education and on-the-jobtrainingincreases steady-state human capital per
worker, which leads to an increase in output per
worker.
In the long run, output per worker depends not only
on how much society saves but also how much it
spends on education.

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11-4 Physical versus Human Capital

Chapter 11: Saving, Capital Accumulation, and Output

Human Capital, Physical Capital, and Output

In the United States, spending on formal education is about

6.5% of GDP, compared to about 16% investment in physical
capital. This comparison:
Accounts for the fact that education is partly consumption.
Does not account for the opportunity cost of education.
Does not account for the opportunity cost of on-thejob-training.
Depreciation of human capital is slower than that of
physical capital.

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11-4 Physical versus Human Capital

Endogenous Growth

Chapter 11: Saving, Capital Accumulation, and Output

A recent study has concluded that output per worker depends roughly
equally on the amount of physical capital and the amount of human capital
in the economy.
Models that generate steady growth even without technological progress
are called models of endogenous growth, where growth depends on
variables such as the saving rate and the rate of spending on education.
Output per worker depends on the level of both physical capital per
worker and human capital per worker.
Is technological progress unrelated to the level of human capital in the
economy? Cant a better-educated labor force lead to a higher rate of
technological progress? These questions take us to the topic of the
next chapter: the sources and the effects of technological progress.

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