CHAPTER 12

Productivity

-A country's standard of living depends on its ability to produce goods and services. -This ability depends on productivity, the average quantity of goods and services produced per unit of labor input. Y = Real GDP = Quantity of output produced L = Quantity of Labor So productivity = Y/L (Output per worker)

Why the U.S is still richer than every other large country

1) An entrepreneurial culture 2) A financial system that supports entrepreneurship 3) World class research universities 4) Labor markets that generally link workers and jobs unimpeded by large trade unions, state-owned enterprises, or excessively restrictive labor regulations 5) A growing population, including from immigration 6) A culture (and a tax system) that encourages hard work and long hours 7) A supply of energy that makes North America energy independent 8) A favorable regulatory environment 9) A smaller size of government than other industrial countries 10) A decentralized political system in which states compete

Robert Fogel

According to the late economic historian Robert Fogel, improved health from better nutrition has been a significant factor in long run economic growth. Fogel estimated that in great Britain in 1780, about one in five people were so malnourished that they were in capable of manual labor. Among those who could work, insufficient caloric intake substantially reduce the work effort they could put forth. As nutrition improved, so did workers productivity.

Population Growth around the World: People respond to incentives

Another way in which a country can influence population growth is to apply one of the 10 principles of economics: People respond to incentives. Bearing a child, like any other decision, has an opportunity cost. When the cost rises, people choose to have smaller families. In particular, living with good education and employment prospects tend to want fewer children and those with fewer opportunities outside the home.

Research and Development: Knowledge is Public Good

Most technologically advances come from private research by firms and individual inventors, but there is also a public interest in promoting these efforts. To a large extent, knowledge is a public good: That is, once one person discovers an idea, the idea enter society full full of knowledge and other people can freely use it.

Natural Resources Per Worker

Natural resources are inputs into production that are provided by nature, such as land, rivers, and mineral deposits. Although natural resources can be important, they are not necessary for an economy to be highly productive in producing goods and services. Japan for example, is one of the richest countries in the world despite having few natural resources. International trade makes Japan's success possible.

Promoting Technological Progress

Some economists suggests that world population growth has been an engine of technological progress and economic prosperity, since there are more people, then there are more scientists, inventors, and engineers to contribute to technological advances, which benefit everyone.

Free Trade: Inward-Oriented Policies

Some of the worlds poorest countries have tried to achieve more rapid economic growth by pursuing inward-orientated policies. These policies aim to increase productivity in living standards within the country by avoiding interaction with the rest of the world. Domestic firms often advance the infant-industry argument, claiming that they need protection from foreign competition to thrive and grow. Together with a general distrust of foreigners, this argument has at times led policymakers in less developed countries to impose tariffs and other trade restrictions.

"One of the Ten Principles of Economics is.."

That a country's standard of living DEPENDS on its ability to produce goods and services.

Production function with constant returns to scale

The set is x=1/L Y/L = AF (1, K/L, H/L, N/L ) Y/L = is output per worker, which is a measure of productivity. This equation says that labor productivity depends on the amounts of physical Capital per worker (K/L), human capital per worker (H/L), and natural resources per worker (N/L) and on the dystrophy of technology, as represented by the variable A.

Physical Capital Per Worker

Workers are more productive if they have tools with which to work. The stock of equipment and structures used to produce goods and services are the physical capital, or just capital. For example, when woodworkers make furniture, they use saws, lathes, and drill presses. More tools allow the woodworkers to produce their output more quickly and more accurately.

Innovation and Growth

" future innovations worldwide will not be transformational enough to promote sustained per-capita economic growth rates in the United States in western Europe over the next century as high as those over the past 150 years." What do the economists say? -59% are uncertain -34% disagree -7% agree

Daniel Defoe's novel "Robinson Crusoe"

About a sailor on a desert island, who lives alone, catches his own fish, grows his own vegetables, and makes his own clothes. Crusoe's activities- such as the production and consumption of his own goods and services, are to be looked at an example of a simple economy Looking at Crusoe as an example, it is easy to see that productivity is the key determinant of living standards and that growth in productivity is the key determinant of growth in living standards.

Research and Development

The primary reason that living standards are higher today than they were a century ago is that technological knowledge has advanced.

Saving and Investment

Because Capital is a produced factor of production, a society can change the amount of capital it has. If today the economy produces a large quantity of new capital goods, then tomorrow it will have a larger stock of capital and be able to produce more goods and services. Thus, one way to raise future productivity is to devote more current resources to the production of capital.

Technological Knowledge vs. Human Capital

-Technological knowledge refers to society's understanding of how to produce goods and services -Human capital results from the effort people expend to acquire this knowledge -Both are important for productivity Technological knowledge is the quality of society's textbooks, whereas human capital is the amount of time that the population has spent reading them. Workers productivity depends on both.

Technological Knowledge Forms

1) Some technology is common knowledge — after one person used it, everyone becomes aware. Example: Henry Ford successfully introduced assembly-line production, other carmakers quickly followed suit. 2) Other technology is proprietary — it is known only by the company that discovers it. Example: Coca-Cola Company, for instance, knows the secret recipe for making its famous soft drink. Still other technology is proprietary for a short time. When a pharmaceutical company discovers a new drug, the patent system gives that company a temporary right to be its exclusive manufacturer. ALL forms of technological knowledge are important for the economy's production of goods and services.

An economy's GDP measures what two things at once?

1) The total income earned by everyone in the economy. 2)The total expenditure on the economy's output of goods and services. GDP can measure these two things simultaneously because, for the economy as a whole, they must be equal. Put simply, an economy's income is the economy's output.

Economic Prosperity depends in part on favorable political institutions

A country with an efficient court system, honest government officials, and a stable constitution will enjoy a higher standard of living than in a country with a poor court system, corrupt officials, and frequent revolutions and coups.

Diluting the Capital Stock

According to these theories, high population growth reduces GDP per worker because rapid growth in the number of workers forces the capital stock to be spread more thinly. In other words, when population growth is rapid, each worker is equipped with less capital. A smaller quantity of capital per worker leads to lower productivity and lower GDP per worker.

Foreign Portfolio Investment (FPI)

Alternatively, an American might buy stock in a Mexican Corporation (that is, buy a share in the ownership of the corporation), and the corporation can use the proceeds from the stock sale to build a new factory. An investment financed with foreign money but operated by domestic residents.

World Bank and International Monetary Fund

An organization that tries to encourage the flow of capital to poor countries. This international organization obtains funds from the worlds advanced countries, such as the United States, and uses these resources to make loans to less developed countries so that they can invest in roads, sewer systems, schools, and other types of capital. It also offers the countries advice about how the funds may best be used. The World Bank and it's sister organization, the International Monetary Fund, were set up after World War II. One lesson from the war was that economic distress often leads to physical turmoil, international tensions, and military conflict. Thus, every country has an interest in promoting economic prosperity around the world. The World Bank and the International Monetary Fund were established to achieve that common goal.

Property Rights and Political Stability

Another way policymakers can foster economic growth is by protecting property rights and promoting political stability. An important prerequisite for the prices in to work as an economy wide respect for property rights. Property rights refer to the ability of people to exercise authority over the resources they own. For this reason, court serve an important role in a market economy: They enforce property rights. Through the criminal justice system, the courts discourage theft. In addition, through the civil justice system, the courts ensure that buyers and sellers live up to their contracts.

Diminishing returns

As the stock of capital rises, the extra output produced from an additional unit of capital falls. In other words, when workers already have a large quantity of capital to use in producing goods and services, giving them an additional unit of capital increases their productivity only slightly. Capitals diminishing returns is sometimes called the "diminishing marginal product of capital." Because of diminishing returns, and increase in the saving rate leads to higher growth only for a while. As the higher saving rate allows more capital to be accumulated, the benefits from additional capital become smaller overtime, and so growth slows down. "In the long run, the higher saving rate leads to a higher level of productivity and income but not to higher growth in these variables." According to studies of international data on economic growth, increasing the saving rate can lead to substantially higher growth for a period of several decades.

Education

Education — investment in human capital — is at least as important as investment in physical capital for a country's long run economic success. In the United States, each year of schooling has historically raised a persons wage by an average of about 10%. In less developed countries, where human capital is especially scarce, the gap between the wages of educated and uneducated workers is even larger. Thus, government policy can enhance the standard of living by providing good schools and encouraging the population to take advantage of them.

Example of Property Rights and Political Stability

Example of Property Rights: A mining Company will not make the effort to mine iron ore if it expects the ore to be stolen. The company mines the ore only if it is confident that it will benefit from the ore's subsequent sale. Example of Political Stability: When revolutions and coups are common, there is doubt about whether property rights will be respected in the future. If a revolutionary government might confiscate the capital of some businesses, as was often true after communist revolutions, domestic residents have less incentive to save, invest, and start new businesses. At the same time, foreigners have less incentive to invest in the country. Even the threat of revolution can act to depress a nations standard of living.

Robert Fogel's Studies

Fogel studied these historical trends in part by looking at the height of the population. Short stature can be an indicator of malnutrition, especially during gestation and the early stages of life. Fogel found that as nations develop economically, people eat more and the population gets taller. From 1775 to 1975, the average caloric intake and Great Britain rows by 26% and the height of the average man rows by 3.6 inches. Similarly, during the spectacular economic growth in South Korea from 1962 to 1995, caloric consumption rose by 44% an average meal height rose by 2 inches.

constant returns to scale

If a production function has constant returns to scale, then doubling all inputs causes the amount of output to double as well. xY = AF (xL, xK, xH, xN) A doubling of all inputs would be represented in this equation by x=2. The right side shows the inputs doubling, and the left side shows output doubling.

Foreign Direct and Portfolio Investment

In both cases, Americans provide the resources necessary to increase the stock of capital in Mexico. That is, American savings is being used to finance Mexican investment. Investment from abroad, therefore, does not have the same effect on all measures of economic prosperity. Recall that a country's is gross domestic product (GDP) is the income earned within the country by both residents and nonresidents, whereas a country's gross national product (GNP) is the income earned by residence of the country both at home and abroad. When Ford opens its car factory in Mexico, some of the income the factory generates accrues to people who do not live in Mexico. As a result, foreign investment in Mexico raises the income of Mexicans (measured by GNP) by less than it raises the production in Mexico (measured by GDP).

Population Growth around the world: Diluting the Capital Stock

In developed countries, such as the United States in those in western Europe, the population has only risen about 1% per year in recent decades and is expected to rise even more slowly in the future. By contrast, in many poor African countries, population grows at about 3% per year. This rapid population growth makes it harder to provide workers with the tools and skills they need to achieve higher levels of productivity. Rapid population growth is not the main reason that less developed countries are poor, but some analysis believe that reducing the rate of population growth will help these countries raise their standards of living. In some countries, the school is accomplished directly with laws that regulate the number of children and families may have.

Population Growth: Thomas Robert Malthus

In his book "An Essay on the Principle of Population as it Affects the Future Improvement of Society" Malthus argued that an ever-increasing population would continually strain society's ability to provide for itself. As a result, mankind was doomed to live in poverty. He stated that, "food is necessary to the existence of man", "the passion between the sexes is necessary and will remain nearly in its present state" and "the power of population is infinitely greater than the power in the earth to produce subsistence for man" and that the only check on population growth was "misery and vice" Malthus also stated that "attempts by charities or governments to alleviate poverty were counterproductive, he argued, because they merely allowed the poor to have more children, placing even greater strains on societies productive capabilities"

Education - Opportunity Cost

Investment in human capital, like investment in physical capital, has an opportunity cost. When students are in school, they forgo the wages they could've earned as members of the labor force. In less developed countries, children often drop out of school at an early age, even though the benefit of additional schooling is very high, simply because their labor is needed to support the family.

Foreign Direct Investment

Investment made by a foreign company in the economy of another country. Ford Motor Company might build a car factory in Mexico. A capital investment that is owned and operated by a foreign entity.

Human Capital Per Worker

Is the second determinant of productivity, which is the knowledge and skills that workers acquire through education, training, and experience. Like physical Capital, human capital raises a nations ability to produce goods and services. Also like physical Capital, human capital is a produced factor of production. Producing human capital requires inputs in the form of teachers, libraries, and students time. Indeed, students can viewed as "workers" who have the important job of producing the human capital that will be used in future production.

Michael Kremer "Population Growth and Technological Change: One Million B.C to 1990"

Kremer began by noting that over the broad span of human history, world growth rates have increased with worlds population. The larger population, he concluded, the greater the potential for technological advance.

Height to productivity

Moreover, studies have found that high is an indicator of productivity researchers have found that taller workers tend to earn more. Because wages reflect a workers productivity, this finding suggests that taller workers tend to be more productive. The effect of height on wages is especially pronounced in poorer countries, where malnutrition is a bigger risk. Today, malnutrition is fortunately rare in developed countries such as Great Britain and the United States. But for people in developing nations, poor health and in adequate nutrition remain obstacles to higher productivity and improved living standards. The United Nations estimates that about a quarter of the population in sub-Saharan Africa is under nourished.

Outward-Oriented Policies

Most economist today believe that poor countries are better off pursuing outward-orientated policies that integrate these countries into the world economy. International trade in goods and services can improve the economic well-being of a country's citizens. Trade is, in some ways, a type of technology.

Technological Knowledge

Technological knowledge is the 4th determinant of productivity — which is the understanding of the best ways to produce goods and services. i.e., Hundreds of years ago, most Americans worked on farms because the farm technology available at the time required a high input of labor to feed the entire population. Today, thanks to advances in farm technology, a small fraction of the population can produce enough food to feed the entire country. This technological change freed up labor, which could then be used to produce other goods and services.

Conclusion of Investment Abroad

Nonetheless, investment from abroad is one way for a country to grow. Even though some of the benefits from this investment flow back to the foreign owners, this investment does increase the economy's stock of capital, leading to higher productivity and higher wages. Moreover, investment from abroad is one way for poor countries to learn the state of the art technology developed and used in richer countries. For these reasons, many economist who advice governments in less developed economies advocate policies that encourage investment from abroad. Often, this means removing restrictions that governments have imposed on foreign ownership of domestic capital.

A problem facing some poor countries

One problem facing some poor countries is the brain drain — the emigration of many of the most highly educated workers to rich countries, where these workers can enjoy a higher standard of living. If human capital does have positive externalities, then this brain drain makes those people left behind even poor. This problem offers policymakers a dilemma. On the one hand, the United States and other rich countries have the best systems of higher education, and it would seem natural for poor countries to send their best students abroad to earn higher degrees. On the other hand, those students who have spent time abroad may choose not to return home, and this brain drain reduce the poor nations stock of human capital even further.

Natural Resources Two Forms:

Renewable - A forest is an example of a renewable resource. When one tree is cut down, a seedling can be planted in its place to be harvested in the future. Nonrenewable - Oil is an example of a nonrenewable resource. Because oil is produced by nature over many millions of years, there is only a limited supply. Once the supply of oil I'd depleted, it is impossible to create more.

Education - Economists Argument

Some economist have argued that human capital is particularly important for economic growth because human capital confers positive externalities. An externality is the effect of one persons action on the well-being of a bystander. An educated person, for instance, might generate new ideas about how best to produce goods and services. If these ideas enter society's pool of knowledge so that everyone can use them, then the ideas are an external benefit of education. In this case, the return from schooling for society is even greater than the return for the individual. This argument would justify the large subsidies to human-capital investment that we observe in the form of public education.

Why is so much of Africa poor?

Sub Saharan Africa has a high rate of extreme poverty. 41% of its population lives on less than $1.90 per day, compared with 10% of the population worldwide. 1) Low capital investment: 2) Low educational attainment 3) Poor health 4) High population growth 5) Geographic disadvantages 6) Restricted freedom 7) Rampant corruption 8) The legacy of colonization

Research and Development: Government Encouragement of Technological Knowledge

The US government has long played a role in the creation and dissemination of technological knowledge. A century ago, the government sponsored research about farming methods and advised farmers how best to use their land. More recently, the U.S. government, through the Air Force and NASA, has supported aerospace research; as a result the US is a leading maker of rockets in planes. The government continues to encourage advances and knowledge with research grants from the National Science Foundation in the National Institutes of Health and with tax breaks for firms engaging in research and development.

The link between health and wealth

The casual link between health and wealth runs in both directions. Poor countries are poor in part because their populations are not healthy, and their populations are not healthy in part because they are poor and cannot afford adequate healthcare and nutrition. It is a vicious circle. But this fact opens the possibility of a virtuous circle: Policies that lead to more rapid economic growth would naturally improve health outcomes, which in turn would further promote economic growth.

Physical Capital Per Worker (Recall Information)

The inputs used to produce goods a d services - labor, capital, and so on— are called the "factors of production." An important feature of capital is that it is a "produced" factor of production. That is, capital is an input into the production process that in the past was a output from the production process. i.e: The woodworker uses a lathe to make the leg of a table. Earlier, the lathe was the output of a firm that manufactures lathes. The lathe manufacturer in turn used other equipment to make its product. Thus, capital is a factor of production used to produce all kinds of goods and services, including more capital.

Population Growth: How Population Affects a Society

The most direct effect is on the size of the labor force. A large population means there are more workers to produce goods and services. At the same time, however, a large population means there are more people to consume those goods and services. So while a large population means a larger total output of goods and services, it need not mean a higher standard of living for the typical citizen.

Catch up effect

The property of diminishing returns to capital has another important implication: Other things being equal, it is easier for a country to grow fast if it starts out relatively poor. This effect on initial conditions of subsequent growth is sometimes called the catch up effect. In poor countries, workers like even the most rudimentary tools and, as a result, have low productivity. Thus, small amounts of capital investment can substantially raise these workers productivity. By contrast, workers in rich countries have high productivity partially because they have large amounts of capital with which to work. When the amount of capital per worker is already so high, additional capital investment has a relatively small effect on productivity.

Health and Nutrition

The term human capital usually refers to education, but it can also be used to describe another type of investment in people: expenditures that lead to a healthier population. Other things being equal, healthier workers are more productive. The right investments in the health of the population provide one way for a nation to increase productivity and raise the living standards.

People face trade-offs

This principle is especially important when considering the accumulation of capital. Because resources are scarce, devoting more resources to producing capital requires devoting fewer resources to producing goods and services for current consumption. That is, for society to invest more in capital, it must consume less and save more of its current income. The growth that arises from capital accumulation is not a free lunch: it requires that society sacrifice consumption of goods and services in the present to enjoy higher consumption in the future. At this point, it is import to note that encouraging saving and investment is one way that a government can encourage growth and, in the long run, raise an economy's standard of living.

Population Growth: Why Malthus Theories were Wrong

World population has increased about six fold over the past two centuries, but living standards around the world have significantly increased as well. As a result of economic growth, chronic hunger and malnutrition are less common now than they were in Malthus day. Pesticides, fertilizers, mechanized farm equipment, new crop varieties, and other technological advances that Malthus never imagined have allowed each farmer to feed ever greater numbers of people. Even with more mouths to feed, fewer farmers are necessary because each farmer is much more productive.

The Production Function

Y = AF ( L, K, H, N ) Y = Quantity of Output L = Quantity of Labor K = Quantity of Physical Capital H = Quantity of Human Capital N= Quantity of Natural Resources "A" is a variable that reflects the available production technology. As technology improves, so the economy produces more output from any given combination of inputs.

Research and Development: Government Encouragement of Research

Yet another way in which government policy encourages research is through the patent system. When a person or firm creates an innovative product, such as a new drug, the inventor can apply for a patent. If the product is deemed truly original, the government awards the patent, which gives the inventor the exclusive right to make the product for a specified number of years. In essence, the patent gives the inventor a property right over her invention, turning her new idea from a public good into a private good. By allowing inventors to profit from their inventions — even if only temporarily — the patent system increases the incentive for individuals and firms to engage in research.