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Long-Run Growth. Economic Growth. Economic growth refers to an increase in the total output of an economy. Defined by some economists as the increase of real GDP per capita.
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Economic Growth • Economic growth refers to an increase in the total output of an economy. Defined by some economists as the increase of real GDP per capita. • Modern economic growth is the period of rapid and sustained increase in real output per capita that began in the Western World with the Industrial Revolution.
Economic Growth • The production possibility frontier shows all the combinations of output that can be produced if all society’s scarce resources are fully and efficiently employed. • Economic growth shifts society’s production possibility frontier up and to the right.
The Growth Process:From Agriculture to Industry • Before the Industrial Revolution in Great Britain, every society in the world was agrarian. • Beginning in England around 1750, technical change and capital accumulation increased productivity in two important industries: agriculture and textiles. • More could be produced with fewer resources, leading to new products, more output, and wider choice.
The Sources of Economic Growth • An aggregate production function is the mathematical representation of the relationship between inputs and national output, or gross domestic product. • If you think of GDP as a function of both labor and capital, you can see that an increase in GDP can come about through: • An increase in the labor supply • An increase in physical or human capital • An increase in productivity
An Increase in Labor Supply • An increasing labor supply can generate more output, but if the capital stock remains fixed, the new labor will be less productive (diminishing returns). • Malthus and Ricardo predicted a gloomy future as population outstripped the land’s capacity to produce. However, they forgot the impact of technological change and capital accumulation.
Economic Growth Froman Increase in Labor • Growth in the labor force, without a corresponding increase in the capital stock or technological change might lead to growth of output but declining productivity.
Increases in Physical Capital • An increase in the stock of capital can increase output, even if it is not accompanied by an increase in the labor force.
Increases in Physical Capital • The increase in capital stock is the difference between gross investment and depreciation. • Capital has been increasing faster than the labor force since 1960. When capital expands more rapidly than labor, the ratio of capital to labor (K/L) increases, and this too is a source of increasing productivity.
Increases in Productivity • Growth that cannot be explained by increases in the quantity of inputs can be explained only by an increase in the productivity of those inputs. • The productivity of an input is the amount produced per unit of an input. • Factors that affect the productivity of an input include technological change, other advances in knowledge, and economies of scale.
Increases in Productivity • Technological change affects productivity in two stages: • First there is an advance in knowledge, or an invention. • Then there isinnovation, or the use of new knowledge to produce a new product or to produce an existing product more efficiently. • There are capital-saving innovations, and labor-saving innovations.
Increases in Productivity • External economies of scale are cost savings that result from increases in the size of industries. • Production abatement requirements divert capital and labor from the production of measured output, therefore reducing measured productivity.
Labor Productivity, 1952 – 2000 • Some of the explanations for the slowdown in productivity growth in the 1970s include: • a low rate of saving • increased environmental and government regulations • lack of spending in R&D • high energy costs • However, many of these factors turned around in the 1980s and 1990s yet productivity growth remained low.
Economic Growth and Public Policy • Policy provisions to improve the quality of education include the new Education Individual Retirement Account that allows savings to earn tax free returns as long as the balance is used to pay for educational expenses. • Policies to increase the saving rate include individual retirement accounts that accumulate earnings without paying income tax.
Economic Growth and Public Policy • The amount of capital accumulation is ultimately constrained by its rate of saving. • The tax system and the social security system in the United States are biased against saving. • Some public finance economists favor shifting to a system of consumption taxation rather than income taxation to reduce the tax burden on saving.
Economic Growth and Public Policy • Other public policies to stimulate economic growth include: • policies to stimulate investment • policies to increase research and development • reduced regulations • industrial policy, or government involvement in the allocation of capital across manufacturing sectors.
The Pro-Growth Argument • Advocates of growth believe growth is progress. • New technologies and production methods lead to new and better products. Capital accumulation and new technology improve the quality of life. • In 1995, real GDP per capita was more than twice what it was in 1950. Since the 1950s, incomes have grown twice as fast as prices.
The Pro-Growth Argument • Advocates of growth believe growth is progress. • Growth gives us more choices. • New technologies and production methods lead to new and better products. Capital accumulation and new technology improve the quality of life. • Since the 1950s, incomes have grown twice as fast as prices so we can buy that much more.
The Pro-Growth Argument • Growth saves the most valuable commodity—time. • Growth also improves the quality of things that yield satisfaction directly. • Growth produces jobs and higher incomes. With higher incomes we can better afford the sacrifices needed to help the poor. • When population growth is not accompanied by growth in output, unemployment and poverty increase.
The Anti-Growth Argument • Growth has negative effects on the quality of life. • Growth encourages the creation of artificial needs. • Growth means the rapid depletion of a finite quantity of resources. • Growth requires an unfair income distribution and propagates it.
