Growth
Let’s start with a bit of a joke, or maybe a
mind teaser. Say you are in a bar or
restaurant with 10 other people. Then Bill
Gates walks in. What happened to the per
capita income of the people in the bar? It
rose! Are you any better off? Not unless
Bill gives you some of his income!
In Econ, we look at increases in RGDP per
capita as a sign that we are better off!
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Digress : the handy rule of 70 (Some people say 72)
This idea is about the number of years it takes something to
double in size if growing at rate r (this is an approximation,
but a handy rule none the less)
70 divided by r, where r is expressed as a %, not a decimal.
Example: 3% growth a year 70/3 = 23.33
2% growth a year 70/2 = 35
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So with a RGDP growth rate at 3% the size of the “economic
pie” doubles about every 23 years.
If growth is only 2% it takes about 35 years for the size of the
economy to double.
Why should we care about the growth? Well, the population
tends to grow, does it not? And the growing population wants
a good standard of living, right? So, keep the growth rate up
to keep the standard of living (in the sense of per capita
income – the RGDP divided by the population) at least
constant, or better yet, growing.
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Remember we noted two things about the RGDP in a previous
chapter.
1) Over the long haul, or long term, RGDP has moved
upward and this is called economic growth.
2) In the short term there are economic fluctuations - ups and
downs in the level of RGDP. This shorter term pattern is often
called the business cycle.
Two ideas we want to consider about the long term, associated
with the RGDP, are the RGDP per capita and the RGDP per
capita growth rate.
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RGDP per capita is the RGDP divided by the population. In
this sense it is a measure of what people get on average. It
is generally thought that as the RGDP per capita gets larger
the standard of living, or economic well-being, of the
country is growing.
In the year 2000 the RGDP per capita in the US was around
$34,260. The growth rate was, on average, 1.81% for the
US for the period of time 1870, yes 1870, to the year 2000.
1.81% growth means the economy doubled in size every
70/1.81 = 39 years or so. So over the 130 years the US
economy doubled in size roughly 4 times (in per capita
terms.)
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Let’s perform a trick that will show us an interesting result.
You and I now know that RGDP per capita = RGDP/Pop. Here is
the trick. Let’s multiply this definition by 1, where 1 = the number
of workers divided by the number of workers. We get
RGDP per capita = (RGDP/Pop)(number of workers/number of
workers) and then rearranging we get
RGDP per capita = (RGDP/number of workers)(number of
workers/Population).
If here Y = RGDP
Y/POP = (Y/N)(N/POP).
Y/N is called average labor productivity. So, the RGDP per capita
depends in part on the average labor productivity.
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Here we study what can make average labor productivity grow.
1) Work harder. If labor works harder than perhaps productivity
can grow and we can get more output per worker. But, this
method of getting output is just one, and probably not the most
important, factor in increasing labor productivity.
2) Human capital. Human capital refers to talents, education,
training and skills of workers.
You what to know something? It is easy to kick someone in the
face when you are standing on their shoulders. I mention this
because down through the ages we have accumulated knowledge
about how to do things. In the present day we build on what we
have learned from the past and this has certainly increased our
average labor productivity.
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3) K – Capital
Capital, or physical capital, are the tools we make to help us make
other stuff. These tools make us much more productive in terms of
ability to generate output.
I was watching the history channel one day and there was a
program about lumber. It was mentioned that the tools used to cut
wood have been refined in such a way that per tree we can get
more pieces of lumber. Basically the teeth of the saws have been
made smaller and better. This enhances the output per worker.
4) Natural resources and Land. The quality of land in a country
contributes to average labor productivity, but what gives a boost is
discovering more of the other natural resources we have. This
would include petroleum and metals and stuff like that.
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5) Technology
Think about personal computers today. They really are pieces
of capital. But they are more sophisticated today and the same
size box today does now more than ever. So we have had
technological advancement.
In the US economy we have had tremendous advancement in
areas such as transportation, communications, manufacturing
and medicine.
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6) Entrepreneurship and management. You have probably
heard of the names Ford, Carnegie, Rockefeller, Walton and
Gates. These folks, and many more like them, are called
entrepreneurs and they have started new enterprises. Their
work has often lead to improvements in the way we do things
and thus labor productivity has been enhanced.
7) Political and legal environment. How would you like it if
you had to give me 5 bucks every day? You probably
wouldn’t like it. You might even think your private property
is being taken unjustly and maybe you wouldn’t produce
stuff so you wouldn’t have the 5 bucks.
Governments have a role in making average labor
productivity higher by establishing rule (laws) that are
conducive to productivity. Well defined property rights help
promote productivity because we know what we can do with 10
the resources we control.
So, up to know we have considered factors that have increased
our ability to make output – that have contributed to economic
growth. Next let’s look at how we might go about enhancing
these ideas.
Increasing Human Capital
Many governments provide education free to the public as
consumer with the idea that the increased knowledge gained will
enhance productivity. Governments can also make the tax
environment less burdensome when folks engage in activity that
enhances worker knowledge.
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Saving and Investment
For now let’s broadly define saving as our income not
consumed. We saw in a previous section on production
possibilities that as we consume less - save more - we can
devote more to the accumulation of capital goods. This
accumulation of capital goods is called investment and depends
on saving.
Countries that tend to save more have greater capital
accumulation and higher RGDP levels.
Even if a country does not save much it can accumulate more
capital goods if foreigners bring their savings there. This
foreign interaction could take two forms: foreign direct
investment or foreign portfolio investment.
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Foreign direct investment is when a company owns and operates a
segment of its business in another country. Ford Motor Company
assembly lines in other countries is an example of this, or a
Mercedes Benz assembly line in the US. Foreign portfolio
investment is foreign money helping a business but operated by
domestic residents.
So, whether we save or have foreigners contribute, more
investment in capital goods means the economy can grow.
Diminishing returns
You and I know that when you give people tools (capital goods) to
work with their output grows because tools help us do things
quicker and better. But, given all other factors, the increases in
output slow down as you continue to increase capital because at
some point we just can’t use all the tools all the time. So, more13
tools means more output, but at diminishing rates.
The catch-up effect
analogy first - people who have never played golf before will
probably start out shooting about a 60 for nine holes, whereas
folks who have played for some time will shoot around 45 or
better. Now if both types of players play about the same amount
of golf the 60’s shooter will lower scores quicker than the 45
shooter. The logic is the 60’s shooter has beginners stuff to
learn and the finer points of the game, while the 45 shooter only
has to work on the finer points. The beginner stuff is easy and
so the 60 shooter can lower the score by 10 shots quickly,
whereas the finer points are hard to get and thus to lower a 45 to
35 is a lot harder. So, when we are relatively new, the scores
lower more quickly that when we are a veteran. The relatively
new players experience the catch-up effect (terminology here -
not to be confused with the spot on your shirt after eating a
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burger – that is the ketchup effect).
Counties with low rates of capital usage will experience the
catch-up effect early on as they employ more capital, but
eventually diminishing returns will set in. Similarly the rate of
growth of RGDP will be high at first but then the rate of growth
will slow.
The US is often criticized for having low rates of growth
compared to other countries. But, remember we are the biggest
economy in the world.
Exaggerated example: US economy grows from 13 trillion to 14
trillion – a 7.7% gain in GDP. Mexico grows from 2 trillion to 3
trillion – a 50% gain. When you just look at percent US looks
weak.
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Population Growth and some guy named Malthus
Malthus, a man dead for many years now, thought the human race was
doomed to a subsistence level of output. To Malthus the population
would grow faster than output and we would end up with less and less
stuff per person. Eventually this would mean we would all be
miserable – (imagine Tiny Tim’s family before Scrooge has a change
of heart). I like to think that Malthus thought the human race was like
a population of deer. Eventually the size of the population gets so large
that there is not enough food to go around and thus the population dies
off.
The thing Malthus did not foresee was the advancement of technology
and the use of capital goods. Technology and capital goods overcome
population crowding and provide us with increased living standards.
Was Malthus just ahead of his time (but basically right?) or will technology
and capital continue to keep us ahead of the doom and gloom? Only
time will tell, but I think Malthus will always be wrong. But, I thank 16
him for thinking. We must always be vigilant on these matters!