Week5 Monday Slides

EC1B3
Macroeconomics I
Lent Term
Growth Accounting
Growth accounting determines
• The sources of growth in an economy and how they
may change over time
Consider the following production function
Total factor productivity (TFP): stock of ideas

𝐴!
Growth Accounting—1
Apply growth rate rules to the production function.
• The growth rate of each input weighted by its
exponent
Growth Growth rate Growth

rate of of contribution
output knowledge from
Growth workers
contribution
from capital
Growth Accounting—2
Adjust growth rates by labor hours:
TFP growth is often called “the residual.”

Growth Accounting in the United States
Productivity in the United States
From 1973–1995:
• Output in the United States grew half as fast as
1948–1973.
• Known as the productivity slowdown
From 1995–2007:
• Output grew nearly as rapidly as before 1973–1995.
• Known as the new economy
East Asian Growth Miracles
7
East Asian Growth Miracles
8
Understanding TFP Diﬀerences
Output differences between the richest and poorest
countries?
• Differences in capital per person explain about one-
third of the difference.
• TFP explains the remaining two-thirds.
Thus, rich countries are rich because
• they have more capital per person.
• more importantly, they use labor and capital more
efficiently.
Why are some countries more efficient at using capital
and labor?
Understanding TFP Differences
• Human capital
• Health
• Technology (we talked about this)
• Institutions
• Misallocation
Human Capital
Human capital
• Stock of skills that individuals accumulate to make them more
productive
• Education and training
Returns to education
• Value of the increase in wages from additional schooling
Accounting for human capital reduces the residual from a factor of
11 to a factor of 6.
Human capital
Increases in productivity from investment in human
capital
• state schools, subsidized loans for college
Education has significant effects: In the U.S., each
year of schooling raises a worker’s wage by 10%.
But investing in HC also involves a trade-off
between the present & future:
• Spending a year in school requires sacrificing a
year’s wages now to have higher wages later.
12
Health and Nutrition
Health care expenditure is a type of

investment in human capital – healthier
workers are more productive.
In countries with significant malnourishment,
raising workers’ caloric intake raises
productivity:
• Over 1962-95, caloric consumption rose
44% in S. Korea, and economic growth
was spectacular.
• Nobel winner Robert Fogel:
30% of Great Britain’s growth from 1790-
1980 was due to improved nutrition.
13
Case Study: Stunting
Pantawid, piloted in 2008 (Philippine CCT)

Provides cash transfers to poor households,
conditional upon investments in child
education and health, as well as use of
maternal health services.
14
What were the results? Slido.com with #1514944
A. Stunting was eliminated

B. Stunting substantially decreased
C. Stunting stayed the same
D. Stunting slightly increased
E. Stunting substantially increased

For beneficiaries, the impacts were
unambiguously positive.
- improved the nutritional status of
younger children among beneficiaries –
40% decrease in severe stunting, which
is a long-run marker of malnutrition
- increased children’s intake of protein-
rich food, an important factor in
avoiding childhood stunting
16

For non-beneficiaries, unintended
consequences
- CCT increased food prices for those not
in the program
- Increased stunting by 34% for non-
beneficiaries children in targeted
villages
Institutions
Even if human capital and technologies are better in
rich countries, why do they have these advantages?
Institutions are in place to foster human capital and
technological growth.
• Property rights
• The rule of law
• Government systems
• Contract enforcement
Colonial origins of development
Acemoglu, Johnson and Robinson (2001): institutions
matter in the long run.
Colonisation process: some places were difficult to colonise,
so Europeans established extractive institutions:
- Slavery
- Plantations
- Gold mines
Only a few settlers had to stay, no incentives to establish
education incentives or stable property rights
Tipically near the Equator in areas ridden by deadly tropical
diseases
Colonial origins of development
Acemoglu, Johnson and Robinson (2001): institutions matter in the
long run.
Places that were easy to colonise, no diseases: inclusive
institutions
- Strong property rights
- Personal freedoms and rights
- Legal system
- Mass education
- North America, Australia and New Zealand

Property Rights and Political Stability
Markets cannot work properly if
there is no respect for property
rights, i.e. the ability of people
to exercise authority over the
resources they own.
• Rule of law
• Expropriation
21
In many developing countries, the justice system doesn’t
work very well:
•contracts aren’t always enforced
•fraud, corruption often go unpunished
•in some, <irms bribe government of<icials for permits
Political instability (e.g., frequent coups) creates
uncertainty over whether property rights will be
protected in the future.
22
When people fear their capital may be stolen by
criminals or confiscated by a corrupt govt., there is
less investment, including from abroad, and the
economy functions less efficiently.
RESULT: lower living standards.
Economic stability, efficiency, and healthy growth
require law enforcement, effective courts, a stable
constitution, and honest government officials.
23
Misallocation
Misallocation
• Resources not being put to their best use
Examples
• Inefficiency of state-run resources
• Political interference
Policy issues: Allocating the economy’s investment, part 1
• In our growth theory, there’s one type of capital.

• In the real world, there are many types, which we can
divide into three categories:
• private capital stock
• public infrastructure
• human capital: the knowledge and skills that workers acquire
through education
• How should we allocate investment among these types?
Policy issues: Allocating the economy’s investment, part 2
Two viewpoints:
1. Equalize tax treatment of all types of capital in all

industries and let the market allocate investment to the
type with the highest marginal product.
2. Industrial policy:
Government should actively encourage investment in
capital of certain types or in certain industries because it
may have positive externalities that private investors don’t
consider.
Possible problems with industrial policy
• The government may not have the ability to “pick

winners” (choose industries with the highest
return to capital or biggest externalities).
• Politics (e.g., campaign contributions) rather than
economics may influence which industries get
preferential treatment.
Policy issues: Establishing the right institutions
• Creating the right institutions is important for

ensuring that resources are allocated to their best
use. Examples:
•Legal institutions, to protect property rights.
•Capital markets, to help financial capital flow to the best
investment projects.
•A corruption-free government, to promote competition,
enforce contracts, etc.
Policy issues: Encouraging technological progress
• Patent laws:
encourage innovation by granting temporary monopolies
to inventors of new products
• Tax incentives for R&D
• Grants to fund basic research at universities
• Industrial policy:
encourages specific industries that are key for rapid
technological progress (subject to the preceding
concerns).
CASE STUDY: Is free trade good for economic growth? Part 1
• Since Adam Smith, economists have argued that

free trade can increase production efficiency and
living standards.
• Research by Sachs & Warner:
• Average annual growth rates, 1970–89
Open Closed
Developed nations 2.3% 0.7%
Developing nations 4.5% 0.7%
CASE STUDY: Is free trade good for economic growth? Part 2
• To determine causation, Frankel and Romer exploit geographic

differences among countries:
• Some nations trade less because they are farther from other nations or
landlocked.
• Such geographic differences are correlated with trade but not with other
determinants of income.
• Hence, they can be used to isolate the impact of trade on income.
• Findings: increasing trade/GDP by 2% causes GDP per capita to rise
1%, other things equal.

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EC1B3

Total factor productivity (TFP): stock of ideas

Growth Growth rate Growth

TFP growth is often called “the residual.”

Health care expenditure is a type of

Pantawid, piloted in 2008 (Philippine CCT)

A. Stunting was eliminated

Pantawid, piloted in 2008 (Philippine CCT)

Pantawid, piloted in 2008 (Philippine CCT)

- North America, Australia and New Zealand

• In our growth theory, there’s one type of capital.

1. Equalize tax treatment of all types of capital in all

• The government may not have the ability to “pick

• Creating the right institutions is important for

• Since Adam Smith, economists have argued that

• Average annual growth rates, 1970–89

• To determine causation, Frankel and Romer exploit geographic

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