Unit 3
Production and Growth
1
A Picture Is Worth a Thousand Statistics
A typical family with all their possessions in the
U.K., an advanced economy
GDP per capital
= $39,040
Child mortality rate = 0.4%
Access to modern sanitation
facilities = 100%
Educational attainment =60% enrolled in higher
education
2
A Picture Is Worth a Thousand Statistics
A typical family with all their possessions in
Mexico, a middle income country
GDP per capita
= $16,640
Child mortality
rate = 1.3%
Access to
modern sanitation
facilities = 85%
Educational attainment =30%
3
A Picture Is Worth a Thousand Statistics
Những vật dụng phổ biến trong một gia đình điển
hình ở Mali, một quốc gia kém phát triển.
GDP per capita
= $1,510
Child mortality
rate = 11.5%
Access to
modern sanitation
facilities = 25%
Educational attainment =7%
4
The Variety of Growth Experiences
5
Economic growth around
the world
• Living standards, as measured by real GDP per
person, vary significantly among nations.
• The poorest countries have average levels of
income that have not been seen in the United
States for many decades.
• Within a country there are large changes in the
standard of living over time.
– Poor countries could become rich if they can
sustain a high level of growth.
6
The rule of compound
growth
• Small differences in growth rate can accumulate
over time.
• The Rule of 70: if a variable increase by x
percent over a term then it will double
in 70/x terms.
7
Variations in the Standard
of Living
• Ranking of countries by income changes substantially over
time
• Poor countries are not necessarily doomed to poverty
forever, e.g. Japan incomes were low in 1860 and are
quite high now
• Rich countries can’t take their status for granted
• They may be overtaken by poorer but faster-growing
countries
8
9
Productivity
• A country’s standard of living depends on its
ability to produce goods and services.
10
Productivity
• Productivity
- The amount of goods and services that a worker can produce
from each hour of work.
• Why productivity is so important
– To understand the large differences in living standards
across countries, we must focus on the production of
goods and services.
– Key determinant of living standards
– Growth in productivity is the key determinant of growth in
living standards
11
Productivity
• Determinants of productivity
- The inputs used to produce goods and services are called
the factors of production.
- The factors of production directly determine productivity.
12
Productivity
• The Factors of Production
– Physical capital (K)
• Stock of equipment and structures
– Human capital (H)
• Knowledge and skills that workers acquire through
education, training, and experience
– Natural resources (N)
• Nature, such as land, rivers, and mineral deposits
– Technological knowledge (A)
• Knowing the best ways to produce
• Different from human capital
13
The Production Function
- Economists often use a production function to describe the
relationship between the quantity of inputs used in production
and the quantity of output from production
Y = A F(L, K, H, N)
- Y: output
- A: available production technology
- L: labor
- K: quantity of physical capital
- H: quantity of human capital
- N: quantity of natural resources
14
The Production Function
• A production function has constant returns to
scale if, for any positive number x, we have:
xY = A F(xL, xK, xH, xN)
Or a doubling of all inputs causes the amount of
output to double as well.
15
The Production Function
• Production functions with constant returns to scale have an
interesting implication.
• Setting x = 1/L
Y/ L = A F(1, K/ L, H/ L, N/ L)
Where:
Y/L = output per worker
K/L = physical capital per worker
H/L = human capital per worker
N/L = natural resources per worker
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The Production Function
Productivity (Y/L) depends on physical capital per
worker (K/L), human capital per worker (H/L), and
natural resources per worker (N/L), as well as the
state of technology, (A).
17
The Production Function
Which of the following policies do you think would be most
effective at boosting growth and living standards in a poor
country over the long run?
A. Offer tax incentives for investment by local firms
B. Offer tax incentives for investment by foreign firms
C. Give cash payments for good school attendance
D. Crack down on government corruption
E. Restrict imports to protect domestic industries
F. Allow free trade
18
Are Natural Resources a Limit to
Growth?
19
20
Economic growth and
public policy
Government Policies That Raise Productivity and Living
Standards
• Encourage saving and investment.
• Encourage investment from abroad
• Encourage education and training.
• Establish secure property rights and maintain political
stability.
• Promote free trade.
• Promote research and development.
21
Saving and Investment
• How to raise future productivity
– Invest more current resources in the production of
capital
– Trade-off
• Devote fewer resources to produce goods and services
for current consumption
22
Diminishing Returns
• As the stock of capital rises, the extra output produced from
an additional unit of capital falls; this property is called
diminishing returns.
• Because of diminishing returns, an increase in the saving
rate leads to higher growth only for a while.
• In the long run, the higher saving rate leads to a higher level
of productivity and income, but not to higher growth in these
areas.
23
Diminishing Returns
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Diminishing Returns and Catching Up
effect
• Catch-up effect
– Countries that start off poor tend to grow more
rapidly than countries that start off rich
• Poor countries
– Low productivity
– Even small amounts of capital investment
• Can increase worker productivity substantially
• So they grow faster with the same increase in
investment
25
Investment from Abroad
• Investment from abroad takes several forms:
– Foreign Direct Investment: Capital investment owned and
operated by a foreign entity.
– Foreign Portfolio Investment: Investments financed with
foreign money but operated by domestic residents.
• Benefits from foreign investment
– Increase the economy’s stock of capital
– Higher productivity
– Higher wages
– State-of-the-art technologies from advanced countries
26
World Bank and IMF
• World Bank
• Encourages flow of capital to poor countries
• Funds from world’s advanced countries
• Makes loans to less developed countries
• World Bank and the IMF
• Established to achieve common goal of promoting
economic prosperity
27
Education
• For a country’s long-run growth, education is at least as
important as investment in physical capital.
• In the United States, each year of schooling raises a
person’s wage, on average, by about 10 percent.
• Education often generates positive externality.
• Thus, one way the government can enhance the standard of
living is to provide schools and encourage the population to
take advantage of them.
28
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
• 1962–1995, 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
29
Health and Nutrition
• Vicious circle
• Countries are poor in part because their populations are
not healthy
• Populations are not healthy in part because they are poor
and cannot afford adequate healthcare and nutrition
• Virtuous circle
• Policies that lead to more rapid economic growth would
naturally improve health outcomes, which in turn would
further promote economic growth
30
Property Rights, Political
• To foster economic growth Stability
• Protect property rights (ability of people to exercise
authority over the resources they own)
• Prerequisite for the price system to work
• Courts: Enforce property rights
• Promote political stability
31
Property Rights, Political
• Stability
Major problem: Lack of property rights
• Contracts are hard to enforce
• Fraud, corruption often goes unpunished
• Firms must bribe government officials for permits
• Political instability (frequent revolutions, coups)
• Creates uncertainty over whether property rights will be
protected in the future
32
Free trade
• Trade can make everyone better off
• Inward-oriented policies
• Aim to raise living standards by avoiding interaction with
other countries
• For example, tariffs, limits on investment from abroad
• Outward-oriented policies
• Promote integration with the world economy
• For example, elimination of restrictions on trade or foreign
investment
33
Free trade
• Trade has similar effects as discovering new technologies
• Improves productivity and living standards
• Countries with inward-oriented policies
• Have generally failed to create growth: Argentina
throughout the 20th century
• Countries with outward-oriented policies
• Have often succeeded: South Korea, Singapore, Taiwan
34
Research and Development
• Technological progress: Main reason why living standards
rise over the long run
• Knowledge is a public good
• Ideas can be shared freely, increasing the productivity of
many
• Policies to promote technological progress:
• Patent laws
• Tax incentives or direct support for private sector R&D
• Grants for basic research at universities
35
Population Growth
• Does more population help growth?
• Economists and other social scientists have long debated
how population growth affects a society
– Larger population means more workers, but also more
consumers
– Stretching natural resources
– Diluting the capital stock
– Promoting technological progress
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37
Why Is So Much of Africa Poor?
• Many of the poorest people on the planet live in sub-Saharan
Africa
• In 2020, GDP per person in this region was only $3,821
(22% of the world average)
• 40% of population lives on less than $1.90 per day
• Discuss some of the reasons (determinants of productivity)
that may explain the low economic development in this area
38
Why Is So Much of Africa Poor?
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
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