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%eventh &dition

Macroeconomics

Principles of

N. Gregory Mankiw

CHAPTER

12

Production

and Growth

W

ojciechGerson(1831-1

901)


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In this chapter,

look for the answers to these questions

What are the facts about living standards andgrowth rates around the world?

Why does productivity matter for livingstandards?

What determines productivity and its growthrate?

How can public policy affect growth and livingstandards?




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33

A typical family with all their possessions in the

U.K., an advanced economy

A typical family with all their possessions in the

U.K., an advanced economy

G! per capita" #$%,&'&

(hild mortality rate" &)*+

High school enrollment" -+

G! per capita" #$%,&'&

(hild mortality rate" &)*+

High school enrollment" -+

av

id.ee

d/

from

012

3.I14W5.4


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44

A typical family with all their possessions in Mexico, a

middle income country

A typical family with all their possessions in Mexico, a

middle income country

G! per capita" #'*,$&

(hild mortality rate" ')%+

High school enrollment" 6'+

G! per capita" #'*,$&

(hild mortality rate" ')%+

High school enrollment" 6'+

!e

ter

0en7e

l8men7e

lph

oto

)com


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55

A typical family with all their possessions in Mali,

a poor country

A typical family with all their possessions in Mali,

a poor country

G! per capita" #',&9&

(hild mortality rate" '6)%+

High school enrollment" $'+

G! per capita" #',&9&

(hild mortality rate" '6)%+

High school enrollment" $'+

!e

ter

0en7e

l8men7elp

ho

to)c

om


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66

GDP percapita, 2012

Growth rate,19702012

(hina #,:$$ 6)*+

;ingapore #%',-&$ 9)6+India #$,-6% $)$+

ew ealand #$:,:' ')9+

1rgentina #'6,'6 ')9+

;audi 1rabia #$',6: '):+

(had #',9$ &)%+

Incomes

and Growth

Around the

World

FACT 1:

2here arevastdifferencesin living

standardsaround theworld)


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77

GDP percapita, 2012

Growth rate,19702012

(hina #,:$$ 6)*+

;ingapore #%',-&$ 9)6+India #$,-6% $)$+

ew ealand #$:,:' ')9+

1rgentina #'6,'6 ')9+

;audi 1rabia #$',6: '):+

(had #',9$ &)%+

Incomes

and Growth

Around the

World

FACT 2:

2here isalso greatvariationin growth

rates acrosscountries)


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Incomes and Growth 1round the World

;ince growth rates vary, the country rankings canchange over time"

!oor countries are not necessarily doomed to

poverty forever, e)g) ;ingapore incomes were

low in '%& and are quite high now)

.ich countries can@t take their status for

granted" 2hey may be overtaken by poorer but

faster/growing countries)


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!!

Incomes and Growth 1round the World

Auestions" Why are some countries richer than others?

Why do some countries grow quickly while

others seem stuck in a poverty trap? What policies may help raise growth rates and

long/run living standards?


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"#"#

!roductivity

.ecall one of the 2en !rinciples from (hap) '" A countrys standard of living depends on its ability to produce g&s.

2his ability depends on productivity,

the average quantity of gBs producedper unit of labor input)

YC real G! C quantity of output produced

LC quantity of laborso productivity CY8LDoutput per workerE


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""""

Why !roductivity Is ;o Important

When a nation@s workers are very productive,real G! is large and incomes are high)

When productivity grows rapidly, so do livingstandards)

What, then, determines productivity and itsgrowth rate?


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"2"2

!hysical (apital !er Worker

.ecall" 2he stock of equipment and structuresused to produce gBs is called Fphysicalcapital,denoted K)

K8LC capital per worker)

!roductivity is higher when the average workerhas more capital Dmachines, equipment, etc)E)

i)e),

an increase in K8Lcauses an increase inY8L)


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"3"3

Human (apital !er Worker

Human capitalDHE"the knowledge and skills workers acquirethrough education, training, and eperience

H8LC the average worker@s human capital

!roductivity is higher when the average workerhas more human capital Deducation, skills, etc)E)

i)e),

an increase in H8Lcauses an increase inY8L)


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"4"4

>atural .esources !er Worker

Natural resourcesDNE" the inputs into productionthat nature provides, e)g), land, mineral deposits

5ther things equal,more Nallows a country to produce moreY)

In per/worker terms,an increase in N8Lcauses an increase inY8L)

;ome countries are rich because they have

abundant natural resourcesDe)g), ;audi 1rabia has lots of oilE)

ut countries need not have much Nto be richDe)g),


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"5"5

2echnological Jnowledge

Technological no!ledge" society@sunderstanding of the best ways to produce gBs

2echnological progress does not only meana faster computer, a higher/definition 2K,

or a smaller cell phone)

It means any advance in knowledge that boostsproductivity Dallows society to get more output

from its resourcesE) e)g), Henry Lord and the assembly line)


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"6"6

2ech) Jnowledge vs) Human (apital

2echnological knowledge refers to society@sunderstanding of how to produce gBs)

Human capital results from the effort peopleepend to acquire this knowledge)

oth are important for productivity)


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"7"7

2he !roduction Lunction 2he production function is a graph or equation

showing the relation between output and inputs" Y C AFDL, K, H, NE

FD Eis a function that shows how inputs are

combined to produce outputMAN is the level of technology

MAN multiplies the function FD E,so improvements in technology Dincreases in MANEallow more output DYE to be produced from anygiven combination of inputs)


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""

2he !roduction Lunction

2he production function has the propertyconstant returns to scale" (hanging all inputsby the same percentage causes output to changeby that percentage) Lor eample,

oubling all inputs Dmultiplying each by :Ecauses output to double"

Y C AFDL, K, H, NE

:Y C AFD:L, :K, :H, :NE

Increasing all inputs '&+ Dmultiplying each by ')'Ecauses output to increase by '&+"

')'Y C AFD')'L, ')'K, ')'H, ')'NE


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"!"!

2he !roduction Lunction

If we multiply each input by '8L, thenoutput is multiplied by '8L"

Y8L C AFD', K8L, H8L, N8LE

2his equation shows that productivityDoutput per workerE depends on"

the level of technology DAE

physical capital per worker

human capital per worker

natural resources per worker

Y C AFDL, K, H, NE


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A C T I V E L E A R I G 1

iscussion question

Which of the following policies do you think wouldbe most effective at boosting growth and livingstandards in a poor country over the long run?

a" 5ffer ta incentives for investment by local firms

#" N N N N N by foreign firms

c" Give cash payments for good school attendance

d" (rack down on govt corruption

e" .estrict imports to protect domestic industries

$" 1llow free trade

g" Give away condoms 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in hole or in part, e!cept "or use as



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2"2"

%C&N&'(C )*&+TH

AN, -./L(C -&L(CY

>et, we look at the ways

public policy can affect

long/run growth in productivityand living standards)


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2222

;aving and Investment

We can boost productivity by increasing K,which requires investment)

;ince resources scarce, producing more capitalrequires producing fewer consumption goods)

.educing consumption C increasing saving)2his etra saving funds the production ofinvestment goods)

(More details in the next chapter.)

Hence, a tradeoff between current and futureconsumption)


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2323

iminishing .eturns and the (atch/=p 3ffect

2he govt can implement policies that raisesaving and investment) (Details in next chapter.)2hen Kwill rise, causing productivity and livingstandards to rise)

ut this faster growth is temporary,due to diminishing returns to capital"

1s Krises, the etra output from an additionalunit of KfallsO)


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5utput perworker

DproductivityE

2he !roduction Lunction B iminishing .eturns

K8L

Y8L

(apital per worker

If workershave little K,

giving them more

increases their

productivity a lot)

If workers already

have a lot of K,

giving them moreincreases

productivity

fairly little)


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the property whereby poor countries

tend to grow more rapidly than rich onesThe catch0up e$$ect:

K8L

Y8L

!oor country

starts here .ich country starts here

!oor country@s

growth

.ich country@s

growth


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2626

3ample of the (atch/=p 3ffect

5ver '%&P'&, the =);) and ;) Jorea devoteda similar share of G! to investment, so youmight epect they would have similar growthperformance)

ut growth was Q%+ in Jorea and only :+ in the=);)

3planation" the catch/up effect)

In '%&, K8Lwas far smaller in Jorea thanin the =);), hence Jorea grew faster)


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2727

Investment from 1broad

2o raise K8Land hence productivity, wages, andliving standards, the govt can also encourage $oreign direct investment"

a capital investment De)g), a factoryE that is

owned B operated by a foreign entity $oreign port$olio investment"

a capital investment financed with foreignmoney but operated by domestic residents

;ome of the returns from these investmentsflow back to the foreign countries that suppliedthe funds)


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2!2!

3ducation

Govt can increase productivity by promotingeducationPinvestment in human capital DHE) !ublic schools, subsidi7ed loans for college

3ducation has significant effects" In the =);),

each year of schooling raises a worker@s wageby '&+)

ut investing in Halso involves a tradeoff

between the present B future";pending a year in school requires sacrificinga year@s wages now to have higher wages later)


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3#3#

Health and >utrition

Health care ependiture is a type of investment inhuman capitalShealthier workers are moreproductive)

In countries with significant malnourishment,

raising workers@ caloric intake raises productivity" 5ver '%:*, caloric consumption rose 99+ in ;)

Jorea, and economic growth was spectacular)

>obel winner .obert Logel"$&+ of Great ritain@s growth from '6&P'-&

was due to improved nutrition)


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3"3"

!roperty .ights and !olitical ;tability

.ecall"Marets are usually a goodway to organi!e economic activity.

2he price system allocates resources

to their most efficient uses) 2his requires respect for property rights, the

ability of people to eercise authority over theresources they own)


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3232


In many poor countries, the Rustice systemdoesn@t work very well" (ontracts aren@t always enforced

Lraud, corruption often go unpunished

In some, firms must bribe govt officials forpermits

!olitical instability De)g), frequent coupsE creates

uncertainty over whether property rights will beprotected in the future)


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3333


When people fear their capital may be stolen bycriminals or confiscated by a corrupt govt,there is less investment, including from abroad,and the economy functions less efficiently)

.esult" lower living standards) 3conomic stability, efficiency, and healthy growth

require law enforcement, effective courts,a stable constitution, and honest govt officials)


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3434

Lree 2rade

(n!ard0oriented policiesDe)g), tariffs, limits on investment from abroadEaim to raise living standards by avoidinginteraction with other countries)

&ut!ard0oriented policiesDe)g), the elimination of restrictions on trade orforeign investmentEpromote integration with the world economy)


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3535

Lree 2rade

.ecall" "rade can mae everyone better off. 2rade has similar effects as discovering new

technologiesSit improves productivity and livingstandards)

(ountries with inward/oriented policies havegenerally failed to create growth)

e)g), 1rgentina during the :&th century)

(ountries with outward/oriented policies haveoften succeeded)

e)g), ;outh Jorea, ;ingapore, 2aiwan after '%&)


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3636

.esearch and evelopment

2echnological progress is the main reason whyliving standards rise over the long run)

5ne reason is that knowledge is a pu#lic good"Ideas can be shared freely, increasing the

productivity of many)

!olicies to promote tech) progress" !atent laws

2a incentives or direct support forprivate sector .B

Grants for basic research at universities


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3737

!opulation Growth

Omay affect living standards in $ different ways"1" ;tretching natural resources

:&& years ago, 0althus argued that pop) growthwould strain society@s ability to provide for itself)

;ince then, the world population has increasedsifold) If 0althus was right, living standardswould have fallen) Instead, they@ve risen)

0althus failed to account for technologicalprogress and productivity growth)


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33

!opulation Growth

2" iluting the capital stock igger population C higher LC lower K8L

C lower productivity B living standards)

2his applies to Has well as K"fast pop) growth C more childrenC greater strain on educational system)

(ountries with fast pop) growth tend to have lower

educational attainment)


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3!3!

!opulation Growth

2o combat this, many developing countries use policyto control population growth)

(hina@s one child per family laws (ontraception education B availability

!romote female literacy to raise opportunity cost of

having babies

2" iluting the capital stock


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4#4#

!opulation Growth

" !romoting tech) progress 0ore people

C more scientists, inventors, engineers

C more frequent discoveries

C faster tech) progress B economic growth

3vidence from 0ichael Jremer"5ver the course of human history,

growth rates increased as the world@spopulation increased

more populated regions grew faster thanless populated ones

!


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A C T I V E L E A R I G !

.eview productivity concepts

4ist the determinants of productivity) 4ist three policies that attempt to raise living

standards by increasing one of the determinants ofproductivity)



!


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1nswers



eterminants of productivity"K8L, physical capital per worker

H8L, human capital per worker

N8L, natural resources per worker

A, technological knowledge

!olicies to boost productivity"

3ncourage saving and investment, to raise K8L

3ncourage investment from abroad, to raise K8L

!rovide public education, to raise H8L

!


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1nswers



eterminants of productivity"K8L, physical capital per workerH8L, human capital per workerN8L, natural resources per worker

A, technological knowledge

!olicies to boost productivity"

!atent laws or grants, to increase A

(ontrol population growth, to increase K8L


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1re >atural .esources a 4imit to Growth?

;ome argue that population growth is depleting the3arth@s non/renewable resources, and thus will limitgrowth in living standards)

ut technological progress often yields ways to

avoid these limits" Hybrid cars use less gas) etter insulation in homes reduces the energy

required to heat or cool them)

1s a resource becomes scarcer, its market pricerises, which increases the incentive to conserve itand develop alternatives)


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CONCLUSION

In the long run, living standards are determined byproductivity)

!olicies that affect the determinants of productivitywill therefore affect the net generation@s living

standards) 5ne of these determinants is saving and

investment)

In the net chapter, we will learn how saving andinvestment are determined, and how policies canaffect them)


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;ummary

2here are great differences across countries inliving standards and growth rates)

!roductivity Doutput per unit of laborE is the maindeterminant of living standards in the long run)

!roductivity depends on physical and humancapital per worker, natural resources per worker,and technological knowledge)

Growth in these factorsSespeciallytechnological progressScauses growth in livingstandards over the long run)




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;ummary

!olicies can affect the following, each of whichhas important effects on growth" ;aving and investment International trade

3ducation, health B nutrition !roperty rights and political stability .esearch and development !opulation growth

ecause of diminishing returns to capital,growth from investment eventually slows down,and poor countries may Mcatch upN to rich ones)