Lesson 6

Achieving faster growth cont

-stimulate saving -stimulate R and D -Target high technology firms -encourage international trade -improve the quality of education

Neoclassical growth theory

-technology change induces saving and investment -the rate of technological change influences the rate of economic growth not vice versa -technological change results from chance

improve the quality of education

-the benefits from education spread beyond the person being educated so there is a tendency to under invest in education

Classical growth theory cont

-the subsistence real wage rate is the minimum real wage rate to maintain life -if the actual real wage rate is less than the subsistence real wage rate, some people cannot survive and the population decreases

target high-technology firms

-the suggestion is that by subsidizing high-technolgoy industries, a nation can enjoy a temporary advantage over its competitors -This is a very risky strategy, because it is unclear that government is better at picking winners than the profit-seeking entrepreneurs

Classical growth theory

-the view that real GDP growth is temporary and that when real GDP per person rises above the subsistence level a population explosion eventually brings real GDP per person back to the subsistence level Thomas Malthus is given most of the credit for the theory, hence the name Malthusian theory

Long-term growth trends

-we are interested in long-term growth primarily because it bring rising incomes per person

Growth theory: 3 theories that attempt to explain causes of economic growth

1) classical growth theory 2) neoclassical growth theory 3) new growth theory

dismal outcome

when the real wage rate exceeds the subsistence level, the population increases

The causes of economic growth: a first look: preconditions for economic growth

-markets -property rights -monetary exchange

Activities that generate ongoing economic growth

-saving and investment in new capital -investment in human capital -discovery of new technologies

Growth accounting: the productivity function

- applying the law of diminishing returns to capital, the law states that if a given number of hours of labor use more capital, the additional output that results from the additional capital get smaller as the amount of capital increases -the one third rules explains how much less

the law of diminishing returns

- as the quality of one input increase with the quantities of all other inputs remaining the same, output increase but by ever smaller increments

Growth theory: New growth theory builds on 4 facts:

- discoveries result from choices and actions (not chance) -Discoveries bring profit, and competition destroys profit -Discoveries can be used by many people at the same time ( they are public goods) - Knowledge is capital that is not subject of the law of diminishing returns

encourage international trade

- free international trade stimulates growth by extracting all the available gains from specialization and exchange -the fastest growing nations re the one with the fastest growing exports and improts

Growth accounting divides growth into two componenets

- growth in capital per hour of labor - technological change: includes everything that contributes to labor productivity growth that is not included in growth in capital per hour

Real GDP growth in the world economy

- the united states has the highest real GDP per person, and Canada has the second highest -Europe's big 4 (France, Germany, Italy, England) were the third richest countries until 1985 when Japan caught them

Growth accounting

-Accounting for the productivity growth slowdown and speedup -we can use the one third rule to study U.S productivity growth and the productivity growth slowdown

From the production function to the productivity function

-For the U.S., approximately (Y= TK^(1/3) L^(2/3)... this is the "one third rule" -where Y= output (real GDP) T= level of technology K= Capital stock L= employment (hours of work)

Growth theories: classical

-Physical resources limited; without advances in technology we must eventually hit diminishing returns

The one third rule

-Robert solow of MIT discovered that on average, with no change in technology, a 1 percent increase in capital per hour of labor brings a one third of a 1 percent increase in real GDP per hour of labor -but the "1/3" on the previous slide is an exponent in a production function

New growth theory: Capital accumulation

-The capital stock grows if saving exceed depreciation -output growth=capital growth

the productivity function

-a relationship that shows how real GDP per hour of labor changes as the amount of capital per hour of labor changes with a give state of technology -the shape of the productivity function reflects the law of diminishing returns

Problems with neoclassical growth theory

-all economies have access to the same technologies, and capital is free to roam the globe seeking the highest available rate of return -this implies that growth rates and income levels per person around the globe converge -in reality, this convergence is slow and does not appear imminent for all countries

stimulate research and development

-b/c new discoveries can be used by everyone, not all the benefit of a discovery falls to the initial discoverer -so there is a tendency to under invest in research and development activity -government subsidies might offset some of the underinvestment

New growth theory: alternative view of the production function

-constant (not diminishing) marginal returns to capital -Simple example with no labor input: Y=AK -one more unit of K always products A extra units of output, no matter how much K is already on hand

how productivity grows

-effect of increase in capital stock (moves the capital up on the curve to right) -effect of technological change (moves the whole curve up)

growth accounting

-growth accounting is used to calculate how much real GDP growth results from growth of labor and capital and how much is attributable to technological change -the key tool is the aggregate production function: Y= F (L, K, T)

Achieving faster growth

-growth accounting tell us that to achieve faster economic growth we must either increase the growth rate of capital per hour of labor or increasing the pace of technological advance

Modern theory of population growth

-if theres is any relationship between income levels and population growth, it is the opposite of that feared by the classical economists -opportunity costs of children has risen, families have become smaller, death rates have fallen - the rate of population growth is virtually independent of the rate of economic growth

Target rate of return and saving

-in neoclassical growth theory, there is a real rate of interest called the steady state target rate of return (determined by technology and saving behavior) -If the current real rate of interest is above the steady state, saving is sufficient to cause capital per hours to grow -if the current real rate is below the steady state, saving not large enough to cause capital per hour to grown, and it shrinks

Growth Accounting: The Slowdown: technology directed toward 2 probelms

1) energy price shocks 1973-1974 and 1979-1980 - fuel inefficient methods of transportation and production were scrapped at an increased rate -technological change focused on saving energy rather than enhancing productivity 2)The environment -the 1970s saw an expansion of laws and resources devoted to protecting the environment and improving the quality of the workplace -those benefits are not included in real GDP

new growth theory

emphasizes the possible capacity of human resources to innovate at a pace that offsets diminishing returns

Neoclassical

essentially the same conclusion, but not because of population

Stimulate saving

higher saving rates may increase the growth rate of capital. Tax incentives might be provided to boost saving