Chapter 11

Economic Growth and the

Wealth of Nations

Copyright © 2021 by W. W. Norton & Company, Inc.

Previously
• Indirect finance is when savers and lenders utilize banks in the
market for loans.
• Direct finance is when borrowers go directly to lenders (for
example, offers of stocks and bonds).
• Bonds are loan contracts that are typically traded in secondary
markets.
• Stocks are ownership shares in firms.
• U.S. Treasury securities are the bonds used by the federal
government to finance debt.
Big Questions
1. Why does economic growth matter?
2. How do resources and technology contribute to
economic growth?
3. What institutions foster economic growth?
4. How are some economists testing new ideas?
Economic Growth and the Wealth of Nations

Wealth Sources of Growth

• Why wealth • Resources
matters
• Technology
• Economic growth
• Institutions
Wealth Matters (1/2)
Wealthier societies provide better living standards, which include
better nutrition, educational opportunities, health care, freedom, and
even sources of entertainment.

Use GDP and GDP per capita as the main indicators.

• GDP is the basic measure of a nation’s income.
• GDP per capita is a basic measure of average living standards.
 Wealth Matters (2/2)
Life Indicators Low High
Income Income
GDP per capita $691 $44,003
Infant Mortality Rate (per 1,000 live births) 47 4
Life expectancy at birth (years) 64 81
Physicians (per 10,000) 3 37
Access to safely managed sanitation service (%) 18 87
Access to electricity (%) 40.9 100
Mobile cellular subscriptions (per 100 people) 60 128
Female/male secondary enrollment (ratio) .36 1.00
Historical Growth
Economic historian Angus Maddison estimated GDP levels for many
nations back to the year AD 1.
Practice What You Know—1
When economists use the phrase “economic growth,” what are they
referring to?
A. percentage changes in real GDP per capita
B. nominal GDP growth
C. real GDP growth
D. average GDP across nations
Practice What You Know—2
The time period in which per capita GDP for the world started to
increase faster than it had in the rest of history began during what
years?
A. 800s
B. 1490s
C. 1800s
D. 1950s
Uneven Economic Growth
Although the world is wealthier than it was two centuries ago, the
gains have not been evenly distributed around the globe.

Country Year Average

income
United 1800 $2,000
States
Liberia 2016 $829
Real Per Capita GDP over 200 Years
Two centuries ago, everyone was poor, and while some countries
have experienced growth, many others have been left behind.
Mathematics of Growth (1/2)
World economic growth might seem very slow, but small amounts of
growth throughout a long period of time can make a huge difference.
Break out of poverty began in the nineteenth century.

Years Growth Rate

1–1800 0.02%
1800–1900 0.64
1900–1950 1.04
1950–2000 2.12
Mathematics of Growth (2/2)
Economic growth is measured as the growth of real GDP per capita.

Real GDP per capita allows us to compare incomes throughout time by

controlling for inflation and population changes.

= %∆𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃 − %∆𝑃𝑟𝑖𝑐𝑒𝑠 − %∆𝑃𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛

= %∆𝑝𝑒𝑟 𝑐𝑎𝑝𝑖𝑡𝑎 𝑅𝑒𝑎𝑙 𝐺𝐷𝑃
Computing Economic Growth

Computing an Economic Growth Rate

U.S. GDP in 2018 (in millions) $20,580,200
U.S. GDP in 2019 (in millions) $21,427,700
Nominal GDP growth 4.1%
– Price growth (inflation) 1.8%
= Real GDP growth 2.3%
– Population growth 0.5%
= Real per capita GDP growth 1.8%
Growth and Income Levels over Time
If your income doubles, that means you can afford twice as much;
however, for that to happen, you would need your income to grow
100%.

So, how long would it take for your income to double?

Approximate by using the rule of 70:

If the annual growth rate is 𝑋%, the size of that variable doubles
!"
every # years.
Rule of 70
While initially it appears to be insignificant, the difference between
1% and 2% growth means that income doubles twice as fast!
Exponential Growth
Even a small growth rate sustained over a few decades can have a
significant effect on living standards.
Practice What You Know—3
If the annual growth rate of an economy is 7%, how long will it take
for income to double?
A. 5 years
B. 6 years
C. 8 years
D. 10 years
Economic Growth, 1950–2016 (1/2)
Economic Growth, 1950–2016 (2/2)
Growth in China
Perhaps the biggest recent growth
story is China.
Twenty years ago, it was among
the world’s poorest nations, but it
has since experienced an annual
growth of 8%.
It will likely be among the
wealthiest nations in the coming
decades.

21
Economic Growth in the U.S. since 1960
Causes of Economic Growth

Economic growth is incredibly important.

But where does it come from?

The sources of economic growth are:

• Resources
• Technology
• Institutions
Resources
• Resources are the inputs used to produce
goods and services.
• Also referred to as factors of production
• Resources comprise:
• Natural resources
• Human capital
• Physical capital
Natural Resources
Natural resources include physical land and the inputs naturally
occurring in or on the land.

Examples: Coal in United States

Oil in Saudi Arabia
Lumber in Canada
Geography affects weather, disease, and trade possibilities.

Land is not enough for growth.

Human Capital
Human capital is the resource represented by the quantity, knowledge,
and skills of the workers in an economy.

It is possible to expand human capital by increasing the number of

workers and educating the existing labor force.

Education is not enough. For many years, India struggled with economic
growth even though it had a very high literacy rate.
Physical Capital
• Capital comprises the tools
and equipment used in the
production of goods and
services.
• The purpose of capital is to
aid in the production of
future output.
• As the quantity of physical
capital per worker rises, so
does output per worker.
Technology (1/3)
Technology is the knowledge available for use in production.

New technology enables us to produce more while using fewer of our

limited resources.

Technological advancement introduces new techniques or methods so

that firms can produce more valuable outputs per unit of input.
Technology (2/3)
Through a series of technological advancements, U.S. farmers can
produce more milk than ever with many fewer cows.
Technology (3/3)
Technology is just one piece of the puzzle.

Economic growth occurs when the resources and technology work

together.

Technological innovations do not occur randomly across the globe.

So, why do some areas innovate (and grow) more than others?

• Why did the United States grow and innovate while Africa didn’t?
Institutions
Institutions are significant practices, relationships, or organizations
in a society.

They are the official and unofficial conditions that shape the
environment in which decisions are made.

These conditions include laws, regulations, and government. They

also include work habits, expectations, and political behavior.
Important Institutions
• Political stability and rule of law
• Private property rights
• Stable money and prices
• Competitive and open markets
• Efficient taxes
Private Property Rights
Private property rights are the rights of individuals to own property,
to use it in production, and to own the resulting output.
• Perhaps the single greatest incentive for voluntary production
• Workers and producers can own a share of what they produce,
so there is an incentive to produce more and grow.

Example: Xiaogang, China, 1978

Xiaogang Agreement
Farmers split the commune into family-owned plots and agreed to
keep surplus agricultural output beyond the government quota.

Result:
• Agricultural boom in Xiaogang
• More output than previous five years combined
• Chinese leaders instituted agricultural reforms in 1980s and
manufacturing reforms in 1990s.
Political Stability and Rule of Law (1/2)
• Consistent and trustworthy enforcement
of a nation’s laws is crucial for economic
growth.

• In an environment of political instability,

there is no incentive to invest in either
human or physical capital because there
is no predictable future payoff.
Political Stability and Rule of Law (2/2)
The World Justice Project shows how high-income nations are also
nations that adhere most closely to the rule of law.
Competitive and Open Markets
There are three market institutions that are essential for economic
growth:
1. Competitive markets
• Ensure that consumers get the lowest prices, and promote
competition and innovation
2. International trade
• Allows nations to reap the benefits from specialization and
trade
3. Flow of funds across borders
• Helps firms access funds so they can invest and increase future
production
Efficient Taxes
Efficient taxes are taxes sufficient to fund the activities of government
while impeding production and consumption decisions as little as
possible.

Taxes have to be high enough to support an effective government but

low enough as to not reduce incentives for production.
Stable Money and Prices
Uncertainty about future prices makes people reluctant to invest,
which decreases future growth possibilities.
In the United States, the Federal Reserve is charged with
administering monetary policy so that inflation is stable.
• The Federal Reserve is designed to reduce incentives for politically
motivated monetary policy, which typically leads to highly variable
inflation rates.
Economists Are Testing New Ideas
The 2019 Nobel Prize in Economics went to three economists
who use randomized controlled trials (RCTs) to study the effects
of public policies.
• Michael Kremer showed that school attendance could be
improved by treating children for hookworms.
• Abhijit Banerjee and Esther Duflo showed that microcredit
business loans reduced poverty less than what was believed.
• Banerjee and Duflo also also studied ways to encourage
farmers in developing countries to buy fertilizer.
Practice What You Know—4
Land, labor, and capital are considered
A. resources.
B. technology.
C. institutions.
D. investments.
Practice What You Know—5
Why is technological advancement important for economic growth?
A. It increases leisure time.
B. It increases prices, helping producers.
C. It allows us to produce more output while using fewer
resources.
D. It allows us to sustain a population while consuming fewer
amounts of goods and services.
Conclusion
• This chapter makes the argument that economic growth is
important to average people.
• It gives a historical perspective on growth, and we’ve seen that
only recently have we improved our standards of living.
• Economic growth is central to modern macroeconomics, and it
also helps us understand how living standards might be improved
around the world.
• Economic growth is driven by resources, technology, and
institutions.