Macroeconomics II. Growth. Recent phenomenon Great diversity of growth experiences across countries. Why do some countries grow and others not?

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1 Macroeconomics II Growth Growth Theory Facts about growth Recent phenomenon Great diversity of growth experiences across countries What drives growth? Inputs Technology Why do some countries grow and others not? Insights into growth miracles and failures 1

2 What is Growth About? 12 United States - Gross Domestic Product Constant Prices - Trillions of US Dollars q1 1960q1 1970q1 1980q1 1990q1 2000q1 Actual series Trend What is Growth About? (cont d) We divide real GDP into two components: Trend: Long-term and very persistent movements in GDP. Cycle: Transient and short-lived fluctuations around the trend. The phenomenon of growth is characterized by the trend: The US has experienced sustained and stable GDP growth over the past 150 years. For pc GDP, the annual growth rate was 1.75% for the period

3 Progress is recent and striking Estimates for the World Statistic Year Population (billions) GDP Per Capita (1990 US $) ,709 Life expectancy Source: Maddison, Millennial Perspective, OECD, 2001, Tables 1-2, 1-5a. Cross-Country Income Comparison Country GDP per capita* United States 27,655 Singapore 25,740 Japan 22,863 Germany 21,116 France 20,534 Britain 18,616 Mexico 7,744 Russia 4,120 China 3,120 *1996 $. PPP adjusted 3

4 Geographic distribution of income Graphs by year Africa Europe + USSR Latin America Western Offshoots Asia Japan Western Europe Some Growth Facts Enormous variation in incomes across countries. Large variation in growth rates: Most poor countries grow slowly Most rich countries grow moderately A few previously poor countries grow very fast Current growth is explosive by historical standards. 4

5 Growth Rate Diversity Growth Rates Have a Huge Impact Compounding is a very powerful source: Growth Rates Growth 1% Actual 2.3% Growth 3% Growth 6% Time GDP pc measured in billions of 2000 chained dollars 5

6 Growth Rates Have Huge Impact (cont d) Previous picture: The implications of small changes in growth rates have enormous consequences for individual welfare. As Nobel laureate Robert Lucas put it: Is there some action a government of India could take that would lead the Indian government to grow like Indonesia s or Egypt s? If so, what exactly? If not, what is it about the nature of India that makes it so? The consequences for human welfare involved in questions like these are simply staggering: Once one starts to think about them, it is hard to think about anything else. Analysis of Growth: Where Does it Come From? Capital (buildings, infrastructure and machines) Output (GDP) Total Factor Productivity (technological knowledge and efficiency) Labor (Hours worked, number of of workers) 6

7 Aggregate Production Function Output = TFP Capital Stock α Labor Hours (1-α ) Real GDP A parameter (a number, 0 < α < 1) Total Factor Productivity Aggregate production function: useful construct to think of how inputs interact to generate real GDP. Role of Inputs More inputs means more output. Diminishing marginal returns to labor. 1 worker = $10 in output Marginal return is 2 workers = $18 in output $8 in output Marginal return is 3 workers = $24 in output $6 in output The same applies to capital. This will be true whenever parameter α < 1. More on this later. 7

8 Where Does Growth Come From? (cont d) Let us rewrite the production function: Y = A K α L 1- α where: Y is real GDP A is Total Factor Productivity K is the capital stock L is the number of hours worked Growth accounting: What changes in inputs were associated with the observed changes in output? Left-hand side must equal right-hand side! Where Does Growth Come From? (cont d) Decompose growth rate of real output, g Y into growth rates of TFP, g A, of the capital stock, g K, and hours, g L. How?... Take logs: lny = lna + α lnk + (1- α) ln L Remember that lny t = lny t lny t-1 = g Y. Therefore: g Y = g A + α g K + (1- α) g L. Given a value for α, and data on Y, K and L, one can compute A (and, consequently, g A ). 8

9 Growth accounting for Japan, Germany, the UK, and the United States, Growth accounting for Japan, Germany, the UK, and the United States,

10 Growth accounting for Japan, Germany, the UK, and the United States, Growth Accounting Japan Capital growth important through out Labor, TFP important US TFP important until 73 Labor important after 73 UK and Germany rely less on labor Overall, capital accumulation and TFP are the most important components of growth 10

11 Growth Accounting in Emerging Markets, Growth Accounting in Emerging Markets (cont d) This group of countries started their growth process later. Overall, capital accumulation was the most important component of growth. Unlike most industrialized countries, TFP played a surprisingly small role in accounting for growth. Increases in labor input were, instead, the second most important component of growth. 11

12 Europe and Asia Total Output: Of Which Capital Labor TFP Golden Age France 5.0% 1.6% 0.3% 3.1% UK 3.0% 1.6% 0.2% 1.2% W. Germany 6.0% 2.2% 0.5% 3.3% Asian Miracle China 6.8% 2.3% 1.9% 2.6% Hong Kong 7.3% 2.8% 2.1% 2.4% Indonesia 5.6% 2.9% 1.9% 0.8% Korea 8.3% 4.3% 2.5% 1.5% Thailand 7.5% 3.7% 2.0% 1.8% Singapore 8.5% 4.4% 2.2% 1.5% Europe relied on capital and TFP Asian countries have relied on capital 12