CH. 8
PRODUCTIVITY, ECONOMIC GROWTH,
& LIVING STANDARDS
Overview
A. *Productivity & The Importance of Growth
B. Employment as a Source of Growth
C. Capital Stock as a Source of Growth
D. Technology
E. *The Cost of Economic Growth
F. *Growth & the LDC’s
A. PRODUCTIVITY & THE IMPORTANCE OF GROWTH
1. Introduction
Parson Thomas Malthus is a name you should remember.
He was one of the major naysayers to Adam Smith and David
Ricardo’s enthusiasm about the possibilities for economic
growth. For him increasing productivity would be to no
avail. He argued that any increases in output/income
would be soon be followed by increases in the population
and thus a return to the wretched conditions of life for
most people. He is remembered for stating that food would
grow 1,2,3 (i.e., in an arithmetic progression) while
people would grow 2,4,8 (i.e., in a geometric
progression).
2. Income per capita.
In economic terms, the standard of living is measured by
what happens to output(income) per person. If we can get
output to increase faster than population increases, the
standard of living will rise.
If %POP 0, the capital stock rises.
i.e., K2001 = K2000 + IN.
8. What can government do to increase investment?
a. Increase the incentive to invest in physical capital
Any government program that increases firm profitability
will increase investment.
-Programs:
Reduce Corporate profits taxes
Institute an investment tax credit
-The mechanism: profitability
Shift the MEC curve (i.e., Investment)
interest rates somewhat
some in investment.
b. Increase the incentive to save
-Programs
Cut personal income taxes
Exempt interest income from taxation
Cut the capital gains tax (i.e., ROI)
Switch to Consumption Taxation.
-The mechanism: The savings function shifts outward
interest rates
movement down the MEC curve (i.e., I)
c. Shrink government’s competition for resources
-Program
Reduce the size of the Budget.
n.b., Some ―G‖ is actually investment for society
-The Mechanism
Deficit
interest rate
Investment
d. Increase the incentive to invest in human capital
-Human capital: the skills and knowledge of the
workforce.
-Programs
Cutting personal income tax rates increases the
ROI to education.
Allowing tax deductions for education expenses
would reduce the cost of education and ROI.
e. Provide incentives for technological change
-Tech Change: The invention/discovery of new
resources, new methods, & new products.
-Programs:
Extend patent protections.
Favorable tax treatment for R&D
D. TECHNOLOGY
1. Technology is essentially the advance of knowledge.
Technological change comes in two ways:
a. Disembodied. When you graduate from Fairfield, if you
have greater skills than your older brother or sister had
when he or she graduated ten years ago, we will site you as
an example of disembodied technological change. You have
more human capital in you—at least that is our goal for you.
b. Embodied. Often new knowledge is embodied in the
products we make. This is very easy to see in the world we
live in. I have never bought a truck for my business or a
car for my personal use that did not have technological
advances in it. Thus, in the production process, when we buy
a new machine, it is generally more productive than the
machine it replaces.
2. Where does technological advance come from?
a. Invention, innovation, diffusion
b. Organization & specialization
i.e., learning curve.
c. Human capital
3. Technology and market failure
Recall the characteristics of a public good: nonrivalness in
consumption and nonexcludability. New ideas have these
qualities, and it is generally agreed that they can offer
spill over benefits for all of society. It is for this
reason that we can justify some government intervention in
the technology market. The government intervenes:
a. by organizing and managing the U.S. patent,
copyright, and trademark systems. What theses systems
do, in effect, is a grant the exclusive right
(monopoly?) to exploit new ideas and expressions to
the successful applicants.
b. By actually funding/subsidizing basic research and
development
4. Measuring technology
a. The growth accounting formula:
1
g(productivity) = --- * g(K/Lh) + g(Tech) (D1)
3
a. Since we already know that the growth in productivity
is measures as output per man-hour (OMH or Y/L), (D1) can
be rearranged as:
1
g(Tech) = g(Y/Lh) - --- g(K/Lh) (D2)
3
c. Example,
Estimate the contribution of technology to the growth in
output in Fairdale between 1560 and 1569. i.e., Use the
growth accounting formula (D2).
Methodology:
Step 1. Collect the data
To use the growth accounting formula, we will need estimates
of output (i.e., Y,Q,O,GDP—whatever you want to call it),
labor-hours, and capital stock.
NIPA Data for Fairdale 1560 to 1569
YEAR GDP Labor-Hours Capital Stock
(ths.d) (ths.d)
1560 100 500 200
1569 200 800 450
Step 2. Calculate the appropriate ratios
1560 1569
Y/Lh = 100/500=0.2 200/800=0.2499
K/Lh = 200/500=0.4 450/800=0.5625
Step 3. Calculate the growth rates of Y/Lh and K/Lh
Recall the growth rate formula from the appendix to Chapter
4:
g = (FV/IV)1/t - 1 (2)
g(Y/Lh) = (0.2499/0.2)10 – 1 = 2.3%
g(K/Lh) = (0.5625/0.4)10 – 1 = 3.5%
Step 4. Apply the growth accounting formula
1
g(Tech) = g(Y/Lh) - --- g(K/Lh) (D2)
3
= 2.3 - 1/3(3.5)
= 1.1%
i.e., Between 1560 and 1569 we estimate that tech change
(the advance of knowledge?) grew by 1.1 percent annually.
n.b., Would this be a good time for me to remind you to
bring a calculator to our next quiz?
5. Technology Policy.
How can we use public policy to stimulate tech. change?
a. Encourage investment in human capital
Recall from EC.11 that the public good case for
education is easy to make for K-12, and not so easy
to make for college and beyond.
b. Encourage R&D
-Tax credits
-Expand the patent/copyright/trademark systems
c. Encourage new capital investment.
i.e., more often than not, new technology is embodied
in new capital.
6.* Externalities: Negative and Positive
a. Negative externalities
When market activity creates spillover costs for
unintentionally involved third parties, we conclude
that a negative externality exists.
E.g., Auto pollution.
b. Positive externalities
When market activity creates spillover benefits for
unintentionally involved third parties, we conclude
that a positive externality exists.
e.g., The lighthouse.
c. The problem with externalities is that the market
price is wrong (i.e., not optimal). In the case of auto
pollution prices are too low (from society’s
perspective). As a result the market produces too much.
In the case of lighthouses or bridges, the price is too
high (from society’s perspective). As a result the
private market produces too few of such goods.
7.* Technology and Public Goods.
a. Recall the distinction made in micro economics
between public goods and private goods.
Private goods:
(e.g., ice cream cone- double scoop of pecan pralines)
--Are rival in consumption.
Every lick you take is a lick I can’t have.
--Exclusion principle prevails.
You paid $1.50, and that is why you got the cone
instead of me. Is that fair?
Public goods:
(e.g., war on terrorism)
--Are non-rival in consumption.
If the U.S. prevails, even those opposed to the war
(the French and American liberals) will benefit. i.e.,
All share in the same victory or defeat.
--Exclusion principle fails.
There is no practical way to deny/exclude those opposed
to the war from its benefits or costs.
a. The market’s under production of public goods may
justify government intervention.
Thus, if you come up with a new technique for teaching
math or appreciation of poetry, there is no way to
exploit your idea and to keep it a secret from your
rivals at the same time. As a result a positive (rather
than normative) argument can be made for government
support of technology.
*E. THE COST OF GROWTH
1. This has been an uplifting chapter, I hope you will
agree, but before we leave it, let us remember that all
economic choices have opportunity costs. There is an
undeniable trade-off between more economic growth and other
goals of society:
a. Budgetary Costs
Decreased taxes on investment require increased taxes
elsewhere (reallocation of the tax burden) or cutbacks in
government spending.
b. Consumption Costs
Increased incentives for investment are also likely to
entail short-run sacrifices by consumers. i.e., New
machinery is an alternative to consumer products.
c. Leisure Costs
Time is the scarcest of all resources. Time spent
working to make more output is also time not spent with your
family.
It has been observed that on their deathbeds, no one has
ever said, ―I wish I had spent more time at the office.‖
2. Growth and the U.S. Income Distribution DT
While income in the U.S. has grown (our PPF continues to
shift outward at a relatively rapid pace), the gains from
economic growth have not been shared equally. Some people
(the lucky, the talented, the harder workers, the better
educated) have experienced personal, real income growth
which vastly exceeds the gains received by others.
Politicians and academics often see this as a bad thing. Is
it?
Over the past 20 years, the distribution of income in the
U.S. has become more unequal. If you believe that everyone
should have the same income, this trend is surely bad.
However, being at the bottom of the income distribution now
is surely better than being at the bottom of the income
distribution 50 years ago. The rich may be richer, but so
are the poor.
3. Growth and Job Security
a. My grandfather only had one job his entire adult life.
I’ve had a few. You are likely to have many.
b. Improving the standard of living requires economic
change. Economic change means that you can’t expect
the security of lifetime employment.
c. Do you want security or a rising SoL?
Industries with the most rapid job growth pay
substantially above the average.
d. Job churning. In any given year about 15% of total
U.S. employment is involved in the process of job
creation and job destruction.
Don’t ever stop working on your resume.
*F. ECONOMIC GROWTH & THE LDC’s
1. Why do the production frontiers of the lesser developed
countries (LDC’s) shift outward more slowly than those of
the developed countries?
a. GDP/POP is so low that savings for society are
negligible. i.e., S 0.
b. High birth rates. Economists and political leaders
contemplating going to war think of people as
resources. This view is doubly important in LDC’s for
a number of reasons:
1.) Religion & culture grant respect and prestige
to large families
2.) Because childhood death rates are so high,
large families increase the probability that
someone will be around to take care of you in
your old age.
3.) In countries where ancestor worship is common,
lots of children means lots of prayers to/for you
after you’ve passed to the next world.
c. Poor physical Infrastructure means that it is
inordinately expensive to produce and to get goods
to market.
d. Ineffective government. One of the legitimate
functions of government according to Adam Smith is
to provide domestic security (i.e., police and
legal system). Where this is lacking, an inordinate
amount of time and other resources must be devoted
to protecting what you have, leaving less time to
increase production.
e. Lack of freedom. Modern liberals don’t like to
hear it, but remember Adam Smith’s advice that is a
king wants to head a rich and powerful nation, he
should allow his subjects to pursue their self
interests. Laissez faire.
Each year, the Heritage Foundation publishes a list
of the world’s countries ordered by the degree of
freedom. When you look at the list, you do not
have to do the math to see that the countries with
the most freedom are also the wealthiest. And those
with little freedom or repressed are the poorest.
Where would you expect to find the Middle Eastern
states on the freedom list? They have oil, so they
must be among the wealthiest. No?
2. What are the policy options for increasing K/L in LDC’s?
a. The Joe Stalin Approach. When the communists gained
control in 1917, Russia was a very poor country and
accordingly, S 0. It was decided that delivery on
the promise of a worker’s paradise could be achieved
for future generations by wringing it out of the backs
of the current generation. As we now know, the
promised future never came. You will have to decide
for yourself whether this is a poor option or that
Papa Joe just implemented it the wrong way.
b. Tax the wealthy. ……. and don’t let them leave the
country with their wealth, which they may try to do.
Even in poor countries there are frequently found some
people who are very wealthy. Their savings (S > 0) can
be tapped to obtain capital that would serve society.
i.e., Bridges & roads do more to push the PPF outward
than mansions.
c. Foreign aid. If you can’t generate capital
internally, gifts from abroad may help (this is sort
of the relationship you currently have with your
parents. No? Who is paying for the development of your
human capital). Unfortunately, the history of foreign
aid does not contain many success stories. By in large
the recipients (leaders) have mismanaged or squandered
it. I hope that you are not doing this with your
parents foreign aid.
d. Decreasing population growth. We’ve argued that
increasing productivity (the key to increasing the
standard of living) rest largely on the ability of
society to increase K/L. If it is hard to increase
capital, decreasing the denominator (L) can achieve
the same result. Of course, how population reduction
is to be fostered is another question. Hopefully, you
won’t be pushing abortion as a desirable technique.
e. Expand Freedom. Let the people pursue their self
interests. As rational maximizers, if allowed to do
so, they will. As the table below indicates, there is
an impressive correlation between economic freedom and
both our measure of the standard of living and life
expectancy as well.
Economic Freedom Index
Per Capita Income and Life Expectancy
Income/Pop Life Exp.
Free Nations $18,108 76
Mostly Free Nations $10,565 73
Restricted Freedom $ 3,440 60
Repressed Nations $ 1,670 55
Source. James Gwartney & Robert Lawson. Economic Freedom of the
World, 2000. World Bank. 1999 Economic Development Indicators.