Chapter 3

EconomicGrowth:

Concepts andPatterns

Divergent Patterns of Divergent Patterns of Economic growthEconomic growth

GDP per GDP per capita (1996 capita (1996 PPP)PPP)

YY20032003

YY19601960

Average Average Annual Annual growth growth raterate

Income as a Income as a share of US share of US IncomeIncome

19601960 20032003 19601960 20032003

SenegalSenegal 18181818 15571557 0.860.86=86%=86%

-0.22-0.22 0.150.15 0.040.04

BotswanBotswanaa

958958 82328232 8.598.59=859%=859%

5.335.33 0.080.08 0.220.22

Factor Accumulation, Factor Accumulation, Productivity Growth, and Productivity Growth, and Economic GrowthEconomic Growth Factor accumulationFactor accumulation

– AvailabilityAvailability– Productive UseProductive Use

Productivity GrowthProductivity Growth– EfficiencyEfficiency– Technological changeTechnological changeLeads to major shifts in the Leads to major shifts in the

composition of outputcomposition of output

Factor accumulationFactor accumulation

Productivity GrowthProductivity Growth

Saving, Investment, Saving, Investment, and Capital and Capital AccumulationAccumulation1.1. New Investment increases the New Investment increases the

capital stockcapital stock The value of new investment must The value of new investment must

be larger than the amount of be larger than the amount of depreciation of existing capital.depreciation of existing capital.

““Capital” can be physical capital, Capital” can be physical capital, human capital, etc., that is, it can human capital, etc., that is, it can be machines, education, hospitals, be machines, education, hospitals, etc.etc.

Saving, Investment, Saving, Investment, and Capital and Capital AccumulationAccumulation2.2. Investment is financed by savingInvestment is financed by saving

To produce goods that will produce To produce goods that will produce other goods, we have to give up other goods, we have to give up consumption (i.e., save) today.consumption (i.e., save) today.

E.g., education involves staying out of E.g., education involves staying out of the labor market for a while.the labor market for a while.

Saving, Investment, Saving, Investment, and Capital and Capital AccumulationAccumulation3.3. Saving comes from current Saving comes from current

incomeincome Household savingHousehold saving Corporate retained earningsCorporate retained earnings Government surplusGovernment surplus

Saving, Investment, Saving, Investment, and Capital and Capital AccumulationAccumulation Investment is uncertain: Investment is uncertain:

Investments in education only pay Investments in education only pay off ifoff if

– Complementary inputs existComplementary inputs exist– You are allowed by the government to You are allowed by the government to

practicepractice– Your income is not taken by thugsYour income is not taken by thugs– Your skills remain useful throughout Your skills remain useful throughout

your life.your life.

Saving, Investment, Saving, Investment, and Capital and Capital AccumulationAccumulation Sustaining economic growth Sustaining economic growth

requires both generating new requires both generating new investment and ensuring the investment and ensuring the investment is productive.investment is productive.

Growth AccountingGrowth Accounting

http://www.ggdc.net/dseries/growth-accounting.shtml

agWgWg LKKKY 180-90 90-95 95-00 00-04

gY 3.3% 2.5% 4.2% 2.4%

gL 1.7% 1.3% 1.9% -0.4%

gK 4.9% 3.5% 5.8% 3.2%

WK 0.29 0.30 0.30 0.30

a 0.6% 0.5% 1.1% 1.7%

United States

Basic data for growth accounting

Growth AccountingGrowth Accounting

aa is the measure of Total Factor is the measure of Total Factor ProductivityProductivity… and of our ignorance… and of our ignorance

TFP plays less of a role than TFP plays less of a role than factor accumulation in developing factor accumulation in developing countries (compared to industrial countries (compared to industrial countries)countries)

Characteristics of Characteristics of rapidly developing rapidly developing countriescountries Based on cross-country Based on cross-country

regressions: what are the regressions: what are the determinants that makes determinants that makes countries growth differently?countries growth differently?– We don’t know exactly how these We don’t know exactly how these

factors contribute to growthfactors contribute to growth– We don’t know which causes which.We don’t know which causes which.

Macroeconomic and political stability

a) Make investment more predictable

b) Protect the poor

Better health and education make workers more productive:

a) They make businesses more likely to invest

b) They make people more likely to save for the future

Better governance and rule of Better governance and rule of law, better bureaucracies and law, better bureaucracies and property rights, more effective property rights, more effective and less burdensome regulation, and less burdensome regulation, less corruption:less corruption:– They make businesses more likely to They make businesses more likely to

investinvest– They make people more likely to They make people more likely to

save for the futuresave for the future

Diminishing returns Diminishing returns and the production and the production functionfunction Diminishing marginal product of Diminishing marginal product of

capitalcapital Productivity gains typically do not Productivity gains typically do not

have diminishing returnshave diminishing returns

Diminishing returns Diminishing returns and the production and the production functionfunction Diminishing returns means that, Diminishing returns means that,

ceteris paribusceteris paribus, new investment , new investment in a poor country will have a in a poor country will have a much larger impact on output much larger impact on output than the same investment in a than the same investment in a rich country.rich country.

This means:This means:

Diminishing returns Diminishing returns and the production and the production functionfunction1.1. Ceteris paribusCeteris paribus, poor countries , poor countries

have much larger growth have much larger growth potential.potential.

2.2. Ceteris paribusCeteris paribus, growth will slow , growth will slow as a country gets richeras a country gets richer

3.3. Ceteris paribusCeteris paribus, poor and rich , poor and rich countries will converge.countries will converge.

Diminishing returns Diminishing returns and the production and the production functionfunction What is the What is the ceterisceteris that we are that we are

assuming to be assuming to be paribusparibus??– Same production functionSame production function– Same technologySame technology– Same saving rateSame saving rate

If so, then growth is derived If so, then growth is derived primarily from factor primarily from factor accumulation and not productivity accumulation and not productivity growthgrowth

Ceteris paribus

Ceteris not paribus

Divergence?

Convergence in the OECD?

Convergence in countries with similar policies?

Structural ChangeStructural Change

How does the composition of output How does the composition of output change?change?

Engel’s LawEngel’s Law Share of Y produced by agriculture Share of Y produced by agriculture

declines, industry and services get a declines, industry and services get a bigger share.bigger share.

Share of Population in agriculture declines Share of Population in agriculture declines (but not as rapidly as the share of Ag in Y), (but not as rapidly as the share of Ag in Y), industry and services get a bigger share.industry and services get a bigger share.

Patterns of Development, 1950-1970, with Moises. Syrquin, 1975.

Structural ChangeStructural Change

How does the composition of How does the composition of output change?output change?

Population becomes urbanizedPopulation becomes urbanized– Why? Economies of scale; common Why? Economies of scale; common

resources for industrial production.resources for industrial production. Larger share is sold through Larger share is sold through

markets rather than produced for markets rather than produced for own consumptionown consumption

Structural ChangeStructural Change

Expansion of agricultural Expansion of agricultural productivity is key to reducing the productivity is key to reducing the share of workers in agriculture.share of workers in agriculture.