MACROECONOMICS

Economic Growth around the World

Productivity: Its Role and Determinants

 Productivity
 thequantity of goods and services produced from each
unit of labor input
 Why Productivity Is So Important
 Economy’s GDP measures two things at once:
 Total income earned by everyone in the economy
 Total expenditure on the economy’s output of goods and

services.
 Economy as a whole, they must be equal.


Productivity: Its Role and Determinants
 Example:
 Americans live better than Nigerians
because American workers are more productive than
Nigerian workers.
 The Japanese have enjoyed more rapid growth in living

standards than Argentineans because Japanese workers

have experienced more rapid growth in productivity.
=> country’s standard of living depends on its ability to produce
goods and services.
 Why are some economies so much better at producing

goods and services than others?

How Productivity Is Determined

 Determinants of productivity:
 Physical capital
 Human capital

 Natural resources

 Technological knowledge
How Productivity Is Determined

 Physical Capital per Worker

 Workers are more productive if they have tools with
which to work.
 The stock of equipment and structures called

physical capital, or just capital.

 Example: A worker with only basic hand tools can

make less products each week than a

worker with sophisticated and specialized
equipment.
How Productivity Is Determined
 Human Capital per Worker
 Human capital
 knowledge and skills of workers acquire through
education, training, and experience.
 Human capital may from skills accumulated in early

childhood programs, grade school, high

school, college, and on-the-job training for adults in
the labor force.
 Education, training, and experience are less tangible

than lathes, bulldozers, and buildings, but human

capital is similar to physical capital in many ways.
How Productivity Is Determined
 Human Capital per Worker
 Human capital
 Human capital raises a nation’s ability to produce
goods and services.
 Human capital is a produced factor of

production.
 Producing human capital requires inputs in the form of

teachers, libraries, and student time.

 Students can be viewed as “workers” who have the

important job of producing the human capital that will

be used in future production.
How Productivity Is Determined
 Natural Resources per Worker
 Natural resources
 Natural resources are inputs into production that are provided by nature,
such as land, rivers, and mineral deposits.
 Two forms:

 Renewable: A forest

 Nonrenewable: Oil

 Differences in natural resources are responsible for some of the differences

in standards of living around the world.

 Although natural resources can be important, they are not necessary for an

economy to be highly productive in producing goods and services.

 Japan, with few natural but still successful trough international trade
How Productivity Is Determined
 Technological knowledge
 Understanding of the best ways to produce goods and
services.
 Technological change freed up labors and increase

their productivity.
 Technological knowledge takes many forms.
 Common knowledge
 after one person uses it, everyone becomes aware of it.
 Proprietary technology

it is known only by the company that discovers it (Coca Cola)

Short-term proprietary technology (drug manufacturing)
How Productivity Is Determined
 Technological knowledge
 Technological knowledge refers to society’s
understanding vs Human capital refers to the
resources expended transmitting this
understanding to the labor force.
 Example: 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.
Economic Growth and Public Policy
 Saving and Investment
 One way to raise future productivity => devote more current
resources to the production of capital.
 But, because resources are scarce, for invest more in capital,

it must consume less and save more of its current income.

 The growth that arises from capital accumulation => sacrifice

consumption of goods and services in the present to higher

consumption in the future.
 Encouraging saving and investment is one way that a

government can encourage growth => in the long run, raise

an economy’s standard of living.
Economic Growth and Public Policy

 Diminishing Returns and the Catch-Up

Effect
 Suppose government => policies that raise the
nation’s saving rate (the percentage of GDP
devoted to saving rather than consumption)
 Nation saving more => fewer resources to make

consumption => capital stock increases => rising

productivity and rapid growth in
GDP
Economic Growth and Public Policy
 Diminishing Returns and the Catch-Up Effect
 Assuming saving rate remains at higher level => the growth
rate of GDP stay high indefinitely or only for a period of
time?
 Diminishing returns (diminishing marginal product of

capital):
 As the stock of capital rises, the extra output produced from an
additional unit of capital falls
 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.
Economic Growth and Public Policy
 Diminishing returns (diminishing marginal
product of capital):
 Increase in the saving rate => higher growth only for a
while.
 However, as the higher saving rate allows more capital to
be accumulated, the benefits from additional capital
become smaller over time => growth slows down.
 In the long run, higher saving rate => higher level of
productivity and income but not higher growth.
 Increasing saving rate => substantially higher growth for
several decades.
Economic Growth and Public Policy
 Diminishing returns (diminishing marginal product
of capital):
 Other things being equal, it is easier for a country to grow
fast if it starts out relatively poor
 Catch-up effect:
 This effect of initial conditions on subsequent growth
 In poor countries, workers lack of tools => low productivity
 In poor countries, small amounts of capital investment => raise
workers’ productivity
 By contrast, in rich countries, high productivity because they have
large amounts of capital => Additional capital investment has a
relatively small effect on productivity.
 Controlling for other variables, poor countries tend to grow at faster
rates than rich countries.
Economic Growth and Public Policy
 Investment from Abroad
 Several forms:
A capital investment that is owned and operated by a
foreign entity is called foreign direct investment.
(increases host’s productivity and GDP while
additional income back to home in the form of profit)
 An investment financed with foreign money but operated

by domestic residents is called foreign portfolio

investment. (increases home’s productivity and GDP
while additional income back to host in the form of
profit)
Economic Growth and Public Policy
 Investment from Abroad
 GDP - income earned within the country by both residents and nonresidents
while GNP - the income earned by residents of the country both at home and
abroad.
 Investment from abroad is one way for a country to grow => increase the
economy’s stock of capital, leading to higher productivity and higher wages.
 Investment from abroad is one way for poor countries to learn the state-of-
the-art technologies developed and used in richer countries.
 Governments in less developed economies encourage investment from
abroad (removing restrictions).
 An organization encourage the flow of capital to poor countries - World
Bank, International Monetary Fund.
 Funds from the world’s advanced countries 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.
Economic Growth and Public Policy
 Education
 Investment in human capital => investment in physical
capital => long-run economic success.
 Government policy
 Increasestandard of living by providing good schools
 Encouraging the population to take advantage of them.

 Investment in human capital is opportunity cost

 When students are in school, they forgo the wages they could have
earned as members of the labor force
 In less developed countries, children usually drop out
of school at an early age, even though the benefit of additional
schooling is very high (support the family).
Economic Growth and Public Policy

 Education
 Human capital is important for economic growth

Educated person could generate new ideas about how
best to produce goods and services => external benefit of
education.

Highly educated workers can enjoy a higher standard of
living.

U.S and other rich countries provide best systems of
higher education => poor countries to send their best
students abroad

Those students who have spent time abroad may choose
not to return home => reduce the poor nation’s stock of
human capital even further.
Economic Growth and Public Policy
 Health and Nutrition
 Other things being equal, healthier workers are more productive.
 The right investments in the health of the population => increase

productivity => raise living standards => long-run economic growth.

 From research, taller workers => more productive => earn more =>

increase economic growth.

 Poor countries are poor because their populations are not healthy,

their populations are

not healthy because they are poor, cannot afford adequate
healthcare and nutrition.
=> Policies lead to rapid economic growth would naturally improve
health outcomes => promote economic growth.
Economic Growth and Public Policy
 Property Rights and Political Stability
 Policymakers foster economic growth by protecting
property rights and promoting political stability.
 Economy has to coordinate transactions among

these firms, as well as between firms and consumers

as effectively as possible.
 Market prices are the instrument with which the

invisible hand of the marketplace brings supply and

demand into balance
 Property rights - ability of people to exercise

authority over the resources they own.

Economic Growth and Public Policy
 Property Rights and Political Stability
 In
less developed countries, lack of property rights can be
a major problem.
 The system of justice does not work well.
 Contracts are hard to enforce

 Fraud often goes unpunished.

 Government not only fails to enforce property rights but actually

infringes upon them.

 To do business in some countries, firms are expected to bribe

government officials.
 Such corruption impedes the coordinating power of markets.

=> It also discourages domestic saving and investment from abroad.

Economic Growth and Public Policy

 Property Rights and Political Stability

 One threat to property rights is political instability.
 A country with an efficient court system, honest

government officials, and a stable constitution =>

higher standard of living
 country with a poor court system, corrupt officials,

and frequent revolutions and coups => lower

standard of living
Economic Growth and Public Policy
 Free Trade
 Inward-oriented policies
 Increase productivity and living standards within the country by
avoiding interaction with the rest of the world.
 Domestic firms often advance from that because they need

protection from foreign competition to thrive and

grow => tariffs and other trade restrictions
 Outward-oriented policies
 Integrate 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.
Economic Growth and Public Policy
 Research and Development
 Technological knowledge improved the ability to produce goods
and services.
 Most technological advances come from private research by

firms and individual inventors

 Knowledge is a public good: one person discovers an idea =>

the idea enters society’s pool of knowledge => other people can
freely use it.
 Just as government has a role in providing a public good such as

national defense, and encouraging the research and

development of new technologies.
 Patent: gives the inventor the exclusive right to make the

product for a specified number of years.

Economic Growth and Public Policy

 Population Growth
 Large population => more workers to produce
goods and services. (China)
 Large population means => more people

to consume those goods and services => larger

total output of goods and services but not mean a
higher standard of living for the typical citizen.
Economic Growth and Public Policy
 Population growth interacts with the other factors of
production
 Stretching Natural Resources (Malthus’s view)
 “food is necessary to the existence of man” and that “the passion
between the sexes is necessary and will
remain nearly in its present state.”
 “the power of population is infinitely greater than the power in the

earth to produce subsistence for man.”

 Population growth leads to “misery and vice.”

 charities or governments policies to reduce poverty allowed the

poor to have more children => greater strains on society’s

productive capabilities.
Economic Growth and Public Policy
 Stretching Natural Resources (Malthus’s view)
 But,from economic growth, chronic
hunger and malnutrition are less common
 Why Malthus wrong?
 New technology => higher productivity
 Diluting the Capital Stock
 Population growth is rapid, each worker is equipped with less
capital.
 A smaller quantity of capital per worker => lower productivity

and lower GDP per worker

 Countries with high population growth have large numbers of

school-age children => larger

burden on the educational system.
Economic Growth and Public Policy
 Diluting the Capital Stock
 Educational low in countries with high population growth because rapid
population growth => harder to provide workers with high levels of
productivity.
 Reducing rate of population growth => raise standards of living.
 When the cost rises, people choose to have smaller families. Also, women
with good educations and employment prospects => fewer children.
 Equal treatment of women => reduce rates of population growth => raise
standards of living.
 Promoting Technological Progress
 Rapid population growth => engine of technological progress and economic
prosperity.
 More people => more scientists, inventors, and engineers => more
technological advance => benefits everyone.
Economic Growth and Public Policy
 Why is so much of Africa poor?
 Low capital investment
 Low educational attainment

 Poor health

 High population growth

 Geographic disadvantages

 Restricted freedom

 Rampant corruption

 The legacy of colonization

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