Principles of Economics - 3e Chapter 20 Economic Growth

Economic Growth FIGURE Average Daily Calorie Consumption Not only has the number of calories that people consume per day increased , so has the amount of food calories that people are able to afford based on their working wages . Credit of Daily Calorie Intake by Lauren Creative Commons , BY ) CHAPTER OBJECTIVES In this chapter , you will learn about The Relatively Recent Arrival of Economic Growth Labor Productivity and Economic Growth Components of Economic Growth Economic Convergence Introduction to Economic Growth BRING IT HOME Calories and Economic Growth On average , humans need about calories a day to survive , depending on height , weight , and gender . The economist Brad estimates that the average worker in the early earned wages that could afford him food calories . This worker lived in Western Europe . Two hundred years later , that same worker could afford food calories . However , between 1800 and 1875 , just a time span of just 75 years , economic growth was so rapid that western European workers could purchase food calories a day . By 2012 , a low skilled worker in an affluent Western American country could afford to purchase million food calories per day . What caused such a rapid rise in living standards between 1800 and 1875 and thereafter ?

Why is it that many countries , especially those in Western Europe , North America , and parts of East Asia , can feed their populations more than adequately , while others can not ?

We will look at these and other questions as we examine economic growth .

478 20 Economic Growth Every country worries about economic growth . In the United States and other countries , the question is whether economic growth continues to provide the same remarkable gains in our standard of living as it did during the twentieth century . Meanwhile , can countries like Brazil , Egypt , or Poland catch up to the countries , or must they remain in the second tier capita income ?

Of the world population of roughly billion people , about billion are scraping by on incomes that average less than per day , not that different from the standard of living years ago . Can the world poor be lifted from their fearful poverty ?

As the 1995 Nobel laureate in economics , Robert Lucas , once noted 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 . Dramatic improvements in a nation standard of living are possible . After the Korean War in the late , the Republic of Korea , often called South Korea , was one of the poorest economies in the world . Most South Koreans worked in peasant agriculture . According to the British economist Angus Maddison , who devoted work to measuring and population in the world economy , per capita in 1990 international dollars was 854 per year . From the to the early century , a time period well within the lifetime and memory of many adults , the South Korean economy grew rapidly . Over these four decades , per capita increased by more than per year . According to the World Bank , for South Korea now exceeds in nominal terms , placing it among countries like Italy , New Zealand , and Israel . Measured by total in 2015 , South Korea is the economy in the world . For a nation of 50 million people , this transformation is extraordinary . South Korea is a standout example , but it is not the only case of rapid and sustained economic growth . Other East Asian nations , like Thailand and Indonesia , have seen very rapid growth as well . China has grown enormously since it enacted economic reforms around 1980 . per capita in economies like the United States also has grown dramatically albeit over a longer time frame . Since the Civil War , the economy has transformed from a primarily rural and agricultural economy to an economy based on services , manufacturing , and technology . The Relatively Recent Arrival of Economic Growth LEARNING OBJECTIVES By the end of this section , you will be able to Explain the conditions that have allowed for modern economic growth in the last two centuries Analyze the of public policies on an economy economic growth Let begin with a brief overview of spectacular economic growth patterns around the world in the last two centuries . We commonly refer to this as the period of modern economic growth . Later in the chapter we will discuss lower economic growth rates and some key ingredients for economic progress . Rapid and sustained economic growth is a relatively recent experience for the human race . Before the last two centuries , although rulers , nobles , and conquerors could afford some and although economies rose above the subsistence level , the average person standard of living had not changed much for centuries . Progressive , powerful economic and institutional changes started to have a effect in the late eighteenth and early nineteenth centuries . According to the Dutch economic historian Jan van , societies , favorable demographics , global trading routes , and standardized trading institutions that spread with different empires set the stage for the Industrial Revolution to succeed . The Industrial Revolution refers to the widespread use of machinery and the economic and social changes that resulted in the first half of the . Ingenious steam engine , the power loom , and the steam tasks that otherwise would have taken vast numbers to do . The Industrial Revolution began in Great Britain , and soon spread to the United States , Germany , and other countries . The jobs for ordinary people working with these machines were often dirty and dangerous by modern standards , but the alternative jobs of that time in peasant agriculture and industry were often Access for free at

The Relatively Recent Arrival of Economic Growth dirty and dangerous , too . The of the Industrial Revolution typically offered higher pay and a chance for social mobility . A cycle began New inventions and investments generated , the provided funds for more new investment and inventions , and the investments and inventions provided opportunities for further . Slowly , a group of national economies in Europe and North America emerged from centuries of sluggishness into a period of rapid modern growth . During the last two centuries , the average growth rate per capita in the leading industrialized countries has been about per year . What were times like before then ?

Read the following Clear It Up feature for the answer . CLEAR IT UP What were economic conditions like before 1870 ?

Angus Maddison , a quantitative economic historian , led the most systematic inquiry into national incomes before 1870 . Economists recently have and used his methods to compile per capita estimates from year . to 1348 . Table is an important counterpoint to most of the narrative in this chapter . It shows that nations can decline as well as rise . A wide array of forces , such as epidemics , natural and disasters , the inability to govern large empires , and the remarkably slow pace of technological and institutional progress explain declines in income . Institutions are the traditions and laws by which people in a community agree to behave and govern themselves . Such institutions include marriage , religion , education , and laws of governance . Institutional progress is the development and of these institutions to reinforce social order , and thus , economic growth . One example of such an institution is the Magna ( Great Charter ) which the English nobles forced King John to sign in 1215 . The Magna the principles of due process , whereby a free man could not be penalized unless his peers had made a against him . The United States in its own ion later adopted this concept . This social order may have contributed to England per capita in 1348 , which was second to that of northern Italy . In studying economic growth , a country ins framework plays a role . Table also shows relative global equality for almost years . After his , we begin to see divergence in income ( not in the table ) Year Northern Italy Spain England Holland Byzantium Iraq Egypt Japan 800 600 600 600 700 700 700 730 920 730 402 1000 600 820 600 1150 580 680 660 520 1280 670 527 1300 864 892 610 1348 907 919 TABLE Per Capita Estimates in Current International Dollars from AD to 1348 ( Source Bolt and van . The First Update of the Maddison Project . Growth Before 1820 . 2013 ) Another fascinating and fact is the high levels of income , compared to others at that time , attained by the Islamic Empire was founded in Iraq in 730 . At its height , the empire spanned large regions of the Middle East , North Africa , and Spain until its gradual decline over 200 years .

480 20 Economic Growth The Industrial Revolution led to increasing inequality among nations . Some economies took off , whereas others , like many of those in Africa or Asia , remained close to a subsistence standard of living . General calculations show that the 17 countries of the world with the economies had , on average , times the per capita of the worlds poorest economies in 1870 . By 1960 , the most developed economies had times the per capita of the poorest economies . However , by the middle of the twentieth century , some countries had shown that catching up was possible . Japan economic growth took off in the and , with a growth rate of real per capita averaging 11 per year during those decades . Certain countries in Latin America experienced a boom in economic growth in the as well . In Brazil , for example , per capita expanded by an average annual rate of from 1968 to 1973 . In the , some East Asian economies , including South Korea , Thailand , and , saw rapid growth . In these countries , growth rates of 11 to 12 per year in per capita were not uncommon . More recently , China , with its population of nearly billion people , grew at a per capita rate per year from 1984 into the and still average high rates of growth ( more than today ) India , with a population of billion , has shown promising signs of economic growth , with growth in per capita of about per year during the and climbing toward to per year in the and . LINK up Visit this website ( to read about the Asian Development Bank . These waves of economic growth have not reached all shores . In certain African countries like , and , for example , per capita at the start of the was still less than 300 , not much higher than it was in the nineteenth century and for centuries before that . In the context of the overall situation of people around the world , the good economic news from China ( population billion ) and India ( population billion ) is , nonetheless , astounding and heartening . Economic growth in the last two centuries has made a striking change in the human condition . Richard , an economist at the University of Southern California , wrote in 2000 By many measures , a revolution in the human condition is sweeping the world . Most people today are better fed , clothed , and housed than their predecessors two centuries ago . They are healthier , live longer , and are better educated . Women lives are less centered on reproduction and political democracy has gained a foothold . Although Western Europe and its offshoots have been the leaders of this advance , most of the less developed nations in during the century , with the newly emerging nations of Africa the latest to participate . Although the picture is not one of universal progress , it is the greatest advance in the human condition of the world population ever achieved in such a brief span of time . Rule of Law and Economic Growth Economic growth depends on many factors . Key among those factors is adherence to the rule of law and protection of property rights and contractual rights by a country government so that markets can work effectively and . Laws must be clear , public , fair , enforced , and equally applicable to all members of society . Property rights , as you might recall from Environmental Protection and are the rights of individuals and to own property and use it as they see . Ifyou have 100 , you have the right to use that money , whether you spend it , lend it , or keep it in a jar . It is your property . The of property includes physical property as well as the right to your training and experience , especially since your training is what determines your livelihood . Using this property includes the right to enter into contracts with other parties with your property . Individuals or firms must own the property to enter into a contract . Contractual rights , then , are based on property rights and they allow individuals to enter into agreements with others regarding the use of their property providing recourse through the legal system in the event of Access for free at

Labor Productivity and Economic Growth 481 noncompliance . One example is the employment agreement a skilled surgeon operates on an ill person and expects payment . Failure to pay would constitute property theft by the patient . The theft is property the services that the surgeon provided . In a society with strong property rights and contractual rights , the terms of the contract will be , because the surgeon would have recourse through the court system to extract payment from that individual . Without a legal system that enforces contracts , people would not be likely to enter into contracts for current or future services because of the risk of nonpayment . This would make it difficult to transact business and would slow economic growth . The World Bank considers a country legal system effective if it upholds property rights and contractual rights . The World Bank has developed a ranking system for countries legal systems based on effective protection of property rights and governance using a scale from to , with being the lowest and the highest rating . In 2020 , the world average ranking was . The three countries with the lowest ranking of were and , with South at . Their per capita was 875 , and respectively . The World Bank also cites Afghanistan ( per capita ) as having a low standard of living , weak government structure , and lack of adherence to the rule of law , which has stymied its economic growth . The landlocked Central African Republic ( per capita ) has poor economic resources as well as political instability and is a source of children used in human trafficking . Zimbabwe ( per capita ) has had declining and often negative growth for much of the period since 1998 . Land redistribution and price controls have disrupted the economy , and corruption and violence have dominated the political process . Although global economic growth has increased , those countries lacking a clear system rights and an independent court system free from corruption have lagged far behind . Labor Productivity and Economic Growth LEARNING OBJECTIVES By the end of this section , you will be able to Identify the role of labor productivity in promoting economic growth Analyze the sources of economic growth using the aggregate production function Measure an economy rate growth Evaluate the power of sustained growth Sustained economic growth comes from increases in worker productivity , which essentially means how well we do things . In other words , how is your nation with its time and workers ?

Labor productivity is the value that each employed person creates per unit of their input . The easiest way to comprehend labor productivity is to imagine a Canadian worker who can make 10 loaves of bread in an hour versus a worker who in the same hour can make only two loaves . In this example , the Canadians are more productive . More productivity essentially means you can do more in the same amount of time . This in turn frees up resources for workers to use elsewhere . What determines how productive workers are ?

The answer is pretty intuitive . The determinant of labor productivity is human capital . Human capital is the accumulated knowledge ( from education and experience ) skills , and expertise that the average worker in an economy possesses . Typically the higher the average level of education in an economy , the higher the accumulated human capital and the higher the labor productivity . The second factor that determines labor productivity is technological change . Technological change is a combination of in innovation , which is putting those advances to use in a new product or service . For example , the transistor was invented in 1947 . It allowed us to miniaturize the footprint of electronic devices and use less power than the tube technology that came before it . Innovations since then have produced smaller and better transistors that are ubiquitous in products as varied as phones , computers , and escalators . Developing the transistor has allowed workers to be anywhere with smaller devices . People can use these devices to communicate with other workers , measure product quality or do any other task in less time , improving worker productivity .

482 20 Economic Growth The third factor that determines labor productivity is economies of scale . Recall that economies of scale are the cost advantages that industries obtain due to size . Read more about economies of scale in Production Cost and Industry Structure . Consider again the case of the Canadian worker who could produce 10 loaves of bread in an hour . If this difference in productivity was due only to economies of scale , it could be that the Canadian worker had access to a large oven while the US . worker was using a standard residential size oven . Now that we have explored the productivity , let turn to how economists measure economic growth and productivity . Sources of Economic Growth The Aggregate Production Function To analyze the sources of economic growth , it is useful to think about a production function , which is the technical relationship by which economic inputs like labor , machinery , and raw materials are turned into outputs like goods and services that consumers use . A production function describes a or perhaps an industry inputs and outputs . In , we call the connection from inputs to outputs for the entire economy an aggregate production function . Components ofthe Aggregate Production Function Economists construct different production functions depending on the focus of their studies . Figure presents two examples of aggregate production functions . In the first production function in Figure ( a ) the output is . The inputs in this example are workforce , human capital , physical capital , and technology . We discuss these inputs further in the module , Components of Economic Growth . Human capital capital Technology ( a ) Aggregate production function with as its output Human capital Der Person . Physical capital per Per capita Technology per person ( Aggregate production function with per capita as its output FIGURE Aggregate Production Functions An aggregate production function shows what goes into producing Access for free at

Labor Productivity and Economic Growth 483 the output for an overall economy . a ) This aggregate production function has as its output . This aggregate production function has per capita as its output . Because we calculate it on a basis , we already the labor input into the other factors and we do not need to list it separately . Measuring Productivity An economy rate of productivity growth is closely linked to the growth rate of its per capita , although the two are not identical . For example , if the percentage of the population who holds jobs in an economy increases , per capita will increase but the productivity of individual workers may not be affected . Over the long term , the only way that per capita can grow continually is if the productivity of the average worker rises or if there are complementary increases in capital . A common measure of productivity per worker is dollar value per hour the worker contributes to the employer output . This measure excludes government workers , because their output is not sold in the market and so their productivity is hard to measure . It also excludes farming , which accounts for only a relatively small share of the economy . Figure 203 shows an index of output per hour , with 2012 as the base year ( when the index equals 100 ) The index equaled in 2020 . In 1977 , the index equaled about 50 , which shows that workers have more than doubled their productivity since then . 1004 . 9404 204 No We , Lo , vo , Lo , FIGURE Output per Hour worked in the Economy , Output per hour worked is a measure of worker productivity . In the economy , worker productivity rose more quickly in the and the compared with the and . However , these differences are only a few percentage points per year . Look carefully to see them in the changing slope of the line . The average worker produced over twice as much per hour in 2020 than they did in the . Source Department of Labor , Bureau of Labor Statistics . Click to view content ( books pages A graph has an with years progressing from 1955 to 2020 and a axis labeled Percent Change at Annual Rate . The data moves up and down across a zero line indicating change year over year . In 1970 , 1974 , 1981 , 1983 , 2008 , and 2020 , the rate was quite low , as the was undergoing . According to the Department of Labor , productivity growth was fairly strong in the but then declined in the and before rising again in the second half of the and the first half of the 20005 . In fact , the rate of productivity measured by the change in output per hour worked averaged per

484 20 Economic Growth year from 1947 to 1973 dropped to per year from 1973 to 1979 increased to per year from 1979 to 1990 increased again to from 1990 to 2000 increased even more to from 2000 to 2007 and then decreased to from 2007 to 2020 Figure 204 shows average annual rates growth averaged over time since 1947 . 70 Productivity Growth ( Wu ) I i Time Period FIGURE Productivity Growth Since 1947 growth in worker productivity was very high between 1947 and 1973 . It then declined to lower levels in the later and the 19805 . The late and early saw productivity rebound , but then productivity sagged a bit between 2001 and 2020 . Some think the productivity rebound of the late and early marks the start of a new economy built on higher productivity growth , but we can not determine this until more time has passed . Source Department of Labor , Bureau of Labor Statistics . The New Economy Controversy In recent years a controversy has been brewing among economists about the resurgence of US . productivity in the second half of the . One school of thought argues that the United States had developed a new economy based on the extraordinary advances in communications and information technology of the . The most optimistic proponents argue that it would generate higher average productivity growth for decades to come . The , alternatively , argue that even or ten years of stronger productivity growth does not prove that higher productivity will last for the long term . It is hard to infer anything about productivity trends during the later part of the , because the steep recession , with its sharp but not completely synchronized declines in output and employment , complicates any interpretation . While productivity growth was high in 2009 and 2010 ( around ) it has slowed down over the last decade . Productivity growth is also closely linked to the average level of wages . Over time , the amount that are willing to pay workers will depend on the value of the output those workers produce . If a few employers tried to pay their workers less than what those workers produced , then those workers would receive offers of higher wages from other employers . If a few employers mistakenly paid their workers more than what those workers produced , those employers would soon end up with losses . In the long run , productivity per hour is the most important determinant of the average wage level in any economy . To learn how to compare economies in this regard , follow the steps in the following Work It Out feature . Access for free at

Labor Productivity and Economic Growth 485 Comparing the Economies of Two Countries The Organization for Economic and Development ( tracks data on the annual growth rate of real per hour worked . You can these data on the data webpage Growth in per capita , productivity and at this ( website . Step . Visit the website given above and select two countries to compare . Step . On the menu Subject , select per capita , constant prices , and under Measure , select Annual . Then record the data for the countries you have chosen for the most recent years . Step . Go back to the Subject menu and select per hour worked , constant prices , and under Measure again select Annual Select data for the same years for which you selected per capita data . Step . Compare real growth for both countries . Table provides an example of a comparison between Australia and Belgium . Australia 2011 2012 2013 2014 2015 ( Belgium 2011 2012 2013 2014 2015 Real Growth ( Real Worked ( TABLE Step . For both measures , growth in Australia is greater than growth in Belgium for the first four years . In addition , there are fluctuations . Many factors can affect growth . For example , one factor that may have contributed to Australia stronger growth may be its larger of immigrants , who generally contribute to economic growth . The Power of Sustained Economic Growth Nothing is more important for people standard of living than sustained economic growth . Even small changes in the rate of growth , when sustained and compounded over long periods of time , make an enormous difference in the standard of living . Consider Table , in which the rows of the table show several different rates of growth in per capita and the columns show different periods of time . Assume for simplicity that an economy starts with a per capita of 100 . The table then applies the following formula to calculate what will be at the given growth rate in the future at starting date ( growth rate of ) at end date For example , an economy that starts with a of 100 and grows at per year will reach a of 209 after 25 years that is , 100 ( 25 209 . The slowest rate of per capita growth in the table , just per year , is similar to what the United States

486 20 Economic Growth experienced during its weakest years of productivity growth . The second highest rate , per year , is close to what the economy experienced during the strong economy of the late and into the . Higher rates of per capita growth , such as or per year , represent the experience of rapid growth in economies like Japan , Korea , and China . Table 203 shows that even a few percentage points of difference in economic growth rates will have a profound effect if sustained and compounded over time . For example , an economy growing at a annual rate over 50 years will see its per capita rise by a total of 64 , from 100 to 164 in this example . However , a country growing at a annual rate will see ( almost ) the same amount of 100 to 10 years . Rapid rates growth can bring profound transformation . See the following Clear It Up feature on the relationship between compound growth rates and compound interest rates . If the rate of growth is , young adults starting at age 20 will see the average standard of living in their country more than double by the time reach age 30 , and grow more than sixfold by the time they reach age 45 . Growth Value of an original 100 in 10 Value of an original 100 in 25 Value of an original 100 in 50 Rate Years Years Years 110 128 164 134 209 438 163 339 216 685 TABLE Growth of over Different Time Horizons CLEAR IT UP How are compound growth rates and compound interest rates related ?

The formula for growth rates over different periods of time , as Figure 203 shows , is exactly the same as the formula for how a given amount of savings grows at a certain interest rate over time , as presented in Choice in a World of Scarcity . Both formulas have the same ingredients an original starting amount , in one case and in the other case an amount of saving a percentage increase over time , in one case the growth rate and in the other case an interest rate and an amount of time over which this effect happens . Recall that compound interest is interest that is earned on past interest . It causes the total amount of savings to grow dramatically over time . Similarly , compound rates of economic growth , or the compound growth rate , means that we multiply the rate of growth by a base that includes past growth , with dramatic effects over time . For example , in 2020 , the Central Intelligence Agency World Fact Book reported that South Korea had a of trillion . With a growth rate of per year , South Korea will be trillion in years . If we apply the growth rate to each years ending for the next years , we will calculate that at the end of year one , is trillion . In year two , we start with the one value of and increase it by . Year three starts with the two , and we increase it by and so on , as Table depicts . Access for free at

Components of Economic Growth 487 Year Starting Growth Rate Amount Trillion ( Trillion Trillion ( Trillion Trillion ( Trillion Trillion ( Trillion Trillion ( Trillion TABLE Another way to calculate the growth rate is to apply the following formula Future Value Present Value ( Where future value is the value of years hence , present value is the starting amount of trillion , is the growth rate of , and is the number of periods for which we are calculating growth . Future Value ( trillion Components of Economic Growth LEARNING OBJECTIVES By the end of this section , you will be able to Discuss the components of economic growth , including physical capital , human capital , and technology Explain capital deepening and its Analyze the methods employed in economic growth accounting studies Identify factors that contribute to a healthy climate for economic growth Over decades and generations , seemingly small differences ofa few percentage points in the annual rate of economic growth make an enormous difference in per capita . In this module , we discuss some of the components of economic growth , including physical capital , human capital , and technology . The category of physical capital includes the plant and equipment that use as well as things like roads ( also called infrastructure ) Again , greater physical capital implies more output . Physical capital can affect productivity in two ways ( an increase in the physical capital ( for example , more computers of the same quality ) and ( an increase in the quality of physical capital ( same number of computers but the computers are faster , and so on ) Human capital refers to the skills and knowledge that make workers productive . Human capital and physical capital accumulation are similar In both cases , investment now pays off in higher productivity in the future . The category of technology is the joker in the deck . Earlier we described it as the combination of invention and innovation . When most people think of new technology , the invention of new products like the laser , the smartphone , or some new wonder drug come to mind . In food production , developing more seeds is another example of technology . Technology , as economists use the term , however , includes still more . It includes new ways of organizing work , like the invention of the assembly line , new methods for ensuring better quality of output in factories , and innovative institutions that facilitate the process of converting inputs into output . In short , technology comprises all the advances that make the existing machines and other inputs produce more , and at higher quality , as well as altogether new products . It may not make sense to compare the of China and say , simply because of the great difference in population size . To understand economic growth , which is really concerned with the growth in living

488 20 Economic Growth standards of an average person , it is often useful to focus on per capita . Using per capita also makes it easier to compare countries with smaller numbers of people , like Belgium , or Zimbabwe , with countries that have larger populations , like the United States , the Russian Federation , or . To obtain a per capita production function , divide each input in Figure ( a ) by the population . This creates a second aggregate production function where the output is per capita ( that is , divided by population ) The inputs are the average level of human capital per person , the average level of physical capital per person , and the level of technology per Figure ( The result of having population in the denominator is mathematically appealing . Increases in population lower per capita income . However , increasing population is important for the average person only if the rate of income growth exceeds population growth . A more important reason for constructing a per capita production function is to understand the contribution of human and physical capital . Capital Deepening When society increases the level of capital per person , we call the result capital deepening . The idea of capital deepening can apply both to additional human capital per worker and to additional physical capital per worker Recall that one way to measure human capital is to look at the average levels of education in an economy . Figure illustrates the human capital deepening for workers by showing that the proportion of the population with a high school and a college degree is rising . As recently as 1970 , for example , only about half of adults had at least a high school diploma . By the start of the century , more than 80 of adults had graduated from high school . The idea of human capital deepening also applies to the years of experience that workers have , but the average experience level of workers has not changed much in recent decades . Thus , the key dimension for deepening human capital in the economy focuses more on additional education and training than on a higher average level of work experience . ax , Ir , ore Completion Rates for People 25 and Older ( i ac op , 19 ' my Year FIGURE Human Capital Deepening in the . Rising levels of education for persons 25 and older show the deepening of human capital in the economy . Even today , under of adults have completed a year college degree . There is clearly room for additional deepening of human capital to occur . Source Penn World Tables , Figure shows physical capital deepening in the economy . The average worker in the late was working with physical capital worth almost three times as much as that of the average worker of the early Access for free at

Components of Economic Growth 489 19505 . Real . Dollars per Worker 50000 ' FIGURE Physical Capital in the United States The value of the physical capital , measured by plant and equipment , used by the average worker in the economy has risen over the decades . The increase may have leveled off a bit in the and , which were , not coincidentally , times of growth in worker productivity . We see a renewed increase in physical capital per worker in the late , followed by a flattening in the early 20005 . Source Center for International Comparisons of Production , Income and Prices , University of Pennsylvania ) Not only does the current economy have workers with more and improved physical capital than it did several decades ago , but these workers have access to more advanced technologies . Growth in technology is impossible to measure with a simple line on a graph , but evidence that we live in an age of technological marvels is all around in genetics and in the structure of particles , the wireless internet , and other inventions almost too numerous to count . The Patent and Trademark typically has issued more than patents annually in recent years . This recipe for economic in labor productivity , with investments in human capital and technology , as well as increasing physical applies to other economies . South Korea , for example , already achieved universal enrollment in primary school ( the equivalent of kindergarten through sixth grade in the United States ) by 1965 , when Korea per capita was still near its rock bottom low . By the late , Korea had achieved almost universal secondary school education ( the equivalent of a high school education in the United States ) With regard to physical capital , Korea rates of investment had been about 15 of at the start of the , but doubled to by the late and early 19705 . With regard to technology , South Korean students went to universities and colleges around the world to obtain and technical training , and South Korean reached out to study and form partnerships with firms that could offer them technological insights . These factors combined to foster South Korea high rate growth . Growth Accounting Studies Since the late , economists have conducted growth accounting studies to determine the extent to which

490 20 Economic Growth physical and human capital deepening and technology have contributed to growth . The usual approach uses an aggregate production function to estimate how much of per capita economic growth can be attributed to growth in physical capital and human capital . We can measure these two inputs at least roughly . The part of growth that is unexplained by measured inputs , called the residual , is then attributed to growth in technology . The exact numerical estimates differ from study to study and from country to country , depending on how researchers measured these three main factors and over what time horizons . For studies of the economy , three lessons commonly emerge from growth accounting studies . First , technology is typically the most important contributor to economic growth . Growth in human capital and physical capital often explains only less than half of the economic growth that occurs . New ways of doing things are tremendously important . Second , while investment in physical capital is essential to growth in labor productivity and per capita , building human capital is at least as important . Economic growth is notjust a matter of more machines and buildings . One vivid example of the power of human capital and technological knowledge occurred in Europe in the years after World War II ( During the war , a large share of Europe physical capital , such as factories , roads , and vehicles , was destroyed . Europe also lost an overwhelming amount of human capital in the form of millions of men , women , and children who died during the war . However , the powerful combination of skilled workers and technological knowledge , working within a economic framework , rebuilt Europe productive capacity to an even higher level within less than two decades . A third lesson is that these three factors of human capital , physical capital , and technology work together . Workers with a higher level of education and skills are often better at coming up with new technological innovations . These technological innovations are often ideas that can not increase production until they become a part of new investment in physical capital . New machines that embody technological innovations often require additional training , which builds worker skills further . Ifthe recipe for economic growth is to succeed , an economy needs all the ingredients of the aggregate production function . See the following Clear It Up feature for an example of how human capital , physical capital , and technology can combine to impact lives . CLEAR IT UP How do girls education and economic growth relate in countries ?

In the early , according to the World Bank , about 110 million children between the ages of and 11 were not in about of them were girls . In Afghanistan , for example , the literacy rate for those aged forthe period was 62 for males and only 32 for females . In , in West Africa , it was 55 for males and 31 for females . In , Africa most populous country , it was 76 for males and 58 percent for females . Whenever any child does not receive a basic education , it is both a human and an economic loss . In countries , wages typically increase by an average of 10 to 20 with each additional year of education . There is , however , some intriguing evidence that helping girls in countries to close the education gap with boys may be especially important , because of the social role that many of the girls will play as mothers and homemakers . Girls in countries who receive more education tend to grow up to have fewer , healthier , children . Their children are more likely to be better nourished and to receive basic health care like . Economic research on women in economies backs up these . When 20 women obtain one additional year of schooling , as a group they will , on average , have one less child . When women obtain one additional year of schooling , on average one to two fewer women from that group will die in childbirth . When a woman stays in school an additional year , that factor alone means that , on average , each of her children will spend an additional in school . Education for girls is a good investment because it is an investment in economic growth with beyond the current generation . Access for free at

Components of Economic Growth 491 A Healthy Climate for Economic Growth While physical and human capital deepening and better technology are important , equally important to a nation is the climate or system within which these inputs are cultivated . Both the type of market economy and a legal system that governs and sustains property rights and contractual rights are important contributors to a healthy economic climate . A healthy economic climate usually involves some sort of market orientation at the , individual , or level . Markets that allow personal and business rewards and incentives for increasing human and physical capital encourage overall growth . For example , when workers participate in a competitive and labor market , they have an incentive to acquire additional human capital , because additional education and skills will pay off in higher wages . Firms have an incentive to invest in physical capital and in training workers , because they expect to earn higher for their shareholders . Both individuals and look for new technologies , because even small inventions can make work easier or lead to product improvement . Collectively , such individual and business decisions made within a market structure add up to growth . Much of the rapid growth since the late nineteenth century has come from harnessing the power of competitive markets to allocate resources . This market orientation typically reaches beyond national borders and includes openness to international trade . A general orientation toward markets does not rule out important roles for government . There are times when markets fail to allocate capital or technology in a manner that provides the greatest for society as a whole . The government role is to correct these failures . In addition , government can guide or markets toward certain outcomes . The following examples highlight some important areas that governments around the world have chosen to invest in to facilitate capital deepening and technology Education . The Danish government requires all children under 16 to attend school . They can choose to attend a public school ( or a private school . Students do not pay tuition to attend . Thirteen percent of ( school is private , and the government supplies vouchers to citizens who choose private school . Savings and Investment . In the United States , as in other countries , the government taxes gains from private investment . Low capital gains taxes encourage investment and so also economic growth . Infrastructure . The Japanese government in the undertook infrastructure projects to improve roads and public works . This in turn increased the stock of physical capital and ultimately economic growth . Special Economic Zones . The island of is one of the few African nations to encourage international trade in special economic zones ( SEZ ) These are areas of the country , usually with access to a port where , among other , the government does not tax trade . As a result of its SEZ , has enjoyed economic growth since the 19805 . Free trade does not have to occur in an SEZ however . Governments can encourage international trade across the board , or surrender to protectionism . Research . The European Union has strong programs to invest in research . The researchers Abraham Garcia and Pierre demonstrate that which received support from the Austrian government actually increased their research intensity and had more sales . Governments can support research and technical training that helps to create and spread new technologies . Governments can also provide a legal environment that protects the ability of inventors to from their inventions . There are many more ways in which the government can play an active role in promoting economic growth . We explore them in other chapters and in particular in Around the World . A healthy climate for growth in per capita and labor productivity includes human capital deepening , physical capital deepening , and technological gains , operating in a economy with supportive government policies .

492 20 Economic Growth Economic Convergence LEARNING OBJECTIVES By the end of this section , you will be able to Explain economic convergence Analyze various arguments for and against economic convergence Evaluate the speed of economic convergence between countries and the rest of the world Some and economies around the world have shown a pattern of convergence , in which their economies grow faster than those of countries . increased by an average rate of per year in the and per year from 2010 to 2019 in the countries of the world , which include the United States , Canada , the European Union countries , Japan , Australia , and New Zealand . Table 205 lists eight countries that belong to an informal fast growth club . These countries averaged growth ( after adjusting for ) of at least per year in both the time periods from 1990 to 2000 and from 2010 to 2019 . Since economic growth in these countries has exceeded the average of the world income economies , these countries may converge with the countries . The second part lists the slow growth club , which consists of countries that averaged growth per year or less ( after adjusting for ) during the same time periods . The portion of shows growth rates for the countries of the world divided by income . Average Growth Rate of Real Growth Rate of Real Country Fast Growth Club ( or more per year in both time periods ) China India Ireland Mozambique Vietnam Slow Growth Club ( or less per year in both time periods ) Central African Republic France Germany Haiti Italy TABLE Economic Growth around the World ( Source ?

Access for free at Economic Convergence 493 Conn Average Growth Rate of Real Growth Rate of Real Jamaica Japan Switzerland United States ( for reference ) World Overview Low income Middle income TABLE Economic Growth around the World ( Source ?

Each of the countries in Tab has its own unique story of investments in human and physical capital , technological gains , market forces , government policies , and even lucky events , but an overall pattern of convergence is clear . The countries have growth that is faster than that of the countries , which in turn have growth that is faster than that of the countries . Two prominent members of the club are China and India , which between them have nearly 40 of the population . Some prominent members of the club are countries like France , Germany , Italy , and Japan . Will this pattern of economic convergence persist into the future ?

This is a controversial question among economists that we will consider by looking at some of the main arguments on both sides . Arguments Favoring Convergence Several arguments suggest that countries might have an advantage in achieving greater worker productivity and economic growth in the future . A argument is based on diminishing marginal returns . Even though deepening human and physical capital will tend to increase per capita , the law of diminishing returns suggests that as an economy continues to increase its human and physical capital , the marginal gains to economic growth will diminish . For example , raising the average education level of the population by two years from a level to a high school diploma ( while holding all other inputs constant ) would produce a certain increase in output . An additional increase , so that the average person had a college degree , would increase output further , but the marginal gain would be smaller . Yet another additional increase in the level of education , so that the average person would have a bachelors degree , would increase output still further , but the marginal increase would again be smaller . A similar lesson holds for physical capital . If the quantity of physical capital available to the average worker increases , by , say , to ( again , while holding all other inputs constant ) it will increase the level of output . An additional increase from to will increase output further , but the marginal increase will be smaller . countries like China and India tend to have lower levels of human capital and physical capital , so an investment in capital deepening should have a larger marginal effect in these countries than in

494 20 Economic Growth income countries , where levels of human and physical capital are already relatively high . Diminishing returns implies that economies could converge to the levels that the countries achieve . A second argument is that countries may it easier to improve their technologies than high income countries . countries must continually invent new technologies , whereas countries can often ways of applying technology that has already been invented and is well understood . The economist Alexander ( gave this phenomenon a memorable name the advantages of Ofcourse , he did not literally mean that it is an advantage to have a lower standard of living . He was pointing out that a country that is behind has some extra potential for catching up . Finally , optimists argue that many countries have observed the experience of those that have grown more quickly and have learned from it . Moreover , once the people ofa country begin to enjoy the of a higher standard of living , they may be more likely to build and support the institutions that will help provide this standard of living . LINK up View this video ( to learn about economic growth across the world . Arguments That convergence is neither Inevitable nor Likely If the economy growth depended only on the deepening of human capital and physical capital , then we would expect that economy growth rate to slow down over the long run because of diminishing marginal returns . However , there is another crucial factor in the aggregate production function technology . Developing new technology can provide a way for an economy to sidestep the diminishing marginal returns of capital deepening . Figure shows how . The horizontal axis measures the amount of capital deepening , which on this is an overall measure that includes deepening physical and human capital . The amount of human and physical capital per worker increases as you move from left to right , from to to . The diagrams vertical axis measures per capita output . Start by considering the lowest line in this diagram , labeled Technology . Along this aggregate production function , the level of technology is held constant , so the line shows only the relationship between capital deepening and output . As capital deepens from to to and the economy moves from to to , per capita output does the way in which the line starts out steeper on the left but then as it moves to the right shows the diminishing marginal returns , as additional marginal amounts of capital deepening increase output by amounts . The shape of the aggregate production line ( Technology ) shows that the ability of capital deepening , by itself , to generate sustained economic growth is limited , since diminishing returns will eventually set in . Technology Technology Technology Output per capita Capital ( physical and human ) FIGURE Capital Deepening and New Technology Imagine that the economy starts at point , with the level of physical and human capital and the output per capita at . If the economy relies only on capital deepening , while remaining at the technology level shown by the Technology . line , then it would face diminishing marginal Access for free at

Economic Convergence 495 returns as it moved from point to point to point However , now imagine that capital deepening is combined with improvements in technology . Then , as capital deepens from to , technology improves from Technology Technology , and the economy moves from to . Similarly , as capital deepens from to , technology increases from Technology to Technology , and the economy moves from to With improvements in , there is no longer any reason that economic growth must necessarily slow down . Now , bring improvements in technology into the picture . Improved technology means that with a given set of inputs , more output is possible . The production function labeled Technology in the is based on one evel of technology , but Technology is based on an improved level of technology , so for every level of capital deepening on the horizontal axis , it produces a higher level of output on the vertical axis . In turn , production unction Technology represents a still higher level of technology , so that for every level of inputs on the axis , it produces a higher level of output on the vertical axis than either of the other two aggregate functions . Most healthy , growing economies are deepening their human and physical capital and increasing technology at the same time . As a result , the economy can move from a choice like point on the Technology aggregate line to a point like on Technology and a point like on the still higher aggregate production line ( Technology ) With the combination of technology and capital deepening , the rise in per capita in income countries does not need to fade away because returns . The gains from technology can offset the diminishing returns involved with capital deepening . Will technological improvements themselves run into diminishing returns over time ?

That is , will it become continually harder and more costly to discover new technological improvements ?

Perhaps someday , but , at least over the last two centuries since the beginning of the Industrial Revolution , improvements in technology have not run into diminishing marginal returns . Modern inventions , like the internet or discoveries in genetics or materials science , do not seem to provide smaller gains to output than earlier inventions like the steam engine or the railroad . One reason that technological ideas do not seem to run into diminishing returns is that we often can apply widely the ideas of new technology at a marginal cost that is very low or even zero . A worker or group of workers must use a specific additional machine , or an additional year of education . Many workers across the economy can use a new technology or invention at very low marginal cost . The argument that it is easier for a country to copy and adapt existing technology than it is for a country to invent new technology is not necessarily true , either . When it comes to adapting and using new technology , a society performance is not necessarily guaranteed , but is the result of whether the country economic , educational , and public policy institutions are supportive . In theory , perhaps , countries have many opportunities to copy and adapt technology , but if they lack the appropriate supportive economic infrastructure and institutions , the theoretical possibility that backwardness might have certain advantages is of little practical relevance . LINK up Visit this website ( to read more about economic growth in India . The Slowness of Convergence Although economic convergence between the countries and the rest of the world seems possible and even likely , it will proceed slowly . Consider , for example , a country that starts offwith a per capita of , which would roughly represent a typical country today , and another country that starts out at , which is roughly the level in but not impoverished countries like Indonesia , or Egypt . Say that the rich country chugs along at a annual growth rate of per capita , while the poorer country grows at the aggressive rate of per year . After 30 years , per capita in the rich country will be ( that is , while in the poor country it will be ( that is , Convergence has occurred . The rich country used to be 10 times as wealthy as the poor

496 20 Economic Growth one , and now it is only about times as wealthy . Even after 30 consecutive years rapid growth , however , people in the country are still likely to feel quite poor compared to people in the rich country . Moreover , as the poor country catches up , its opportunities for growth are reduced , and its growth rate may slow down somewhat . The slowness of convergence illustrates again that small differences in annual rates of economic growth become huge differences over time . The countries have been building up their advantage in standard of living over than a century in some cases . Even in an optimistic scenario , it will take decades for the countries of the world to catch up . BRING IT HOME Calories and Economic Growth We can tell the story of modern economic growth by looking at calorie consumption over time . The dramatic rise in incomes allowed the average person to eat better and consume more calories . How did these incomes increase ?

The neoclassical growth consensus uses the aggregate production function to suggest that the period of modern economic growth came about because of increases in inputs such as technology and physical and human capital . Also important was the way in which technological progress combined with physical and human capital deepening to create growth and convergence . The issue of distribution of income notwithstanding , it is clear that the average worker can afford more calories in 2020 than in 1875 . Aside from increases in income , there is another reason why the average person can afford more food . Modern agriculture has allowed many countries to produce more food than they need . Despite having more than enough food , however , many governments and multilateral agencies have not solved the food distribution problem . In fact , food shortages , famine , or general food insecurity are caused more often by the failure of government policy , according to the Nobel economist Sen has conducted extensive research into issues of inequality , poverty , and the role of government in improving standards of living . policies that strive toward stable inflation , full employment , education of women , and preservation of property rights are more likely to eliminate starvation and provide for a more even distribution of food . Because we have more food per capita , global food prices have decreased since 1875 . The prices of some foods , however , have decreased more than the prices of others . For example , researchers from the University of Washington have shown that in the United States , calories from zucchini and lettuce are 100 times more expensive than calories from oil , butter , and sugar . Research from countries like India , China , and the United States suggests that as incomes rise , individuals want more calories from fats and protein and fewer from carbohydrates . This has very interesting implications for global food production , obesity , and environmental consequences . Affluent urban India has an obesity problem much like many parts of the United States . The forces of convergence are at work . Access for free at

20 Key Terms 497 Key Terms aggregate production function the process whereby an economy as a whole turns economic inputs such as human capital , physical capital , and technology into output measured as per capita capital deepening an increase by society in the average level human capital per person compound growth rate the rate of growth when multiplied by a base that includes past growth contractual rights the rights of individuals to enter into agreements with others regarding the use of their property providing recourse through the legal system in the event of noncompliance convergence pattern in which economies with low per capita incomes grow faster than economies with high per capita incomes human capital the accumulated skills and education of workers Industrial Revolution the widespread use of machinery and the economic and social changes that occurred in the half of the infrastructure a component of physical capital such as roads and rail systems innovation putting advances in knowledge to use in a new product or service invention advances in knowledge labor productivity the value of what is produced per worker , or per hour worked ( sometimes called worker productivity ) modern economic growth the period of rapid economic growth from 1870 onward physical capital the plant and equipment that use in production this includes infrastructure production function the process whereby a turns economic inputs like labor , machinery , and raw materials into outputs like goods and services that consumers use rule the process laws that protect individual and entity rights to use their property as they see . Laws must be clear , public , fair , and enforced , and applicable to all members of society special economic zone ( SEZ ) area ofa country , usually with access to a port where , among other , the government does not tax trade technological change a combination of in innovation technology all the ways in which existing inputs produce more or higher quality , as well as different and altogether new products Key Concepts and Summary The Relatively Recent Arrival of Economic Growth Since the early nineteenth century , there has been a spectacular process of economic growth during which the world leading those in Western Europe and North per capita at an average rate of about per year . In the last , countries like Japan , South Korea , and China have shown the potential to catch up . The Industrial Revolution facilitated the extensive process of economic growth , that economists often refer to as modern economic growth . This increased worker productivity and trade , as well as the development of governance and market institutions . Labor Productivity and Economic Growth We can measure productivity , the value of what is produced per worker , or per hour worked , as the level of per worker or per hour . The United States experienced a productivity slowdown between 1973 and 1989 . Since then , productivity has rebounded for the most part , but annual growth in productivity in the nonfarm business sector has been less than one percent each year between 2011 and 2016 . It is not clear what productivity growth will be in the coming years . The rate of productivity growth is the primary determinant of an economy rate of economic growth and higher wages . Over decades and generations , seemingly small differences of a few percentage points in the annual rate of economic growth make an enormous difference in per capita . An aggregate production function specifies how certain inputs in the economy , like human capital , physical capital , and technology , lead to the output measured as per capita .

498 20 Questions Compound interest and compound growth rates behave in the same way as productivity rates . Seemingly small changes in percentage points can have big impacts on income over time . Components of Economic Growth Over decades and generations , seemingly small differences ofa few percentage points in the annual rate of economic growth make an enormous difference in per capita . Capital deepening refers to an increase in the amount of capital per worker , either human capital per worker , in the form of higher education or skills , or physical capital per worker . Technology , in its economic meaning , refers broadly to all new methods of production , which includes major inventions but also small inventions and even better forms of management or other types of institutions . A healthy climate for growth in per capita consists of improvements in human capital , physical capital , and technology , in a environment with supportive public policies and institutions . Economic Convergence When countries with lower levels per capita catch up to countries with higher levels per capita , we call the process convergence . Convergence can occur even when both and countries increase investment in physical and human capital with the objective of growing . This is because the impact of new investment in physical and human capital on a country may result in huge gains as new skills or equipment combine with the labor force . In countries , however , a level of investment equal to that of the low income country is not likely to have as big an impact , because the more developed country most likely already has high levels of capital investment . Therefore , the marginal gain from this additional investment tends to be successively less and less . Higher income countries are more likely to have diminishing returns to their investments and must continually invent new technologies . This allows economies to have a chance for convergent growth . However , many economies have developed economic and political institutions that provide a healthy economic climate for an ongoing stream of technological innovations . Continuous technological innovation can counterbalance diminishing returns to investments in human and physical capital . Questions . Explain what the Industrial Revolution was and where it began . Explain the difference between property rights and contractual rights . Why do they matter to economic growth ?

Are there other ways in which we can measure productivity besides the amount produced per hour of work ?

Assume there are two countries South Korea and the United States . South Korea grows at and the United States grows at . For the sake of simplicity , assume they both start from the same fictional income level , What will the incomes of the United States and South Korea be in 20 years ?

By how many multiples will each country income grow in 20 years ?

What do the growth accounting studies conclude are the of growth ?

Which is more important , the or how they are combined ?

What policies can the government of a economy implement to stimulate economic growth ?

List the areas where government policy can help economic growth . Use an example to explain why , after periods of rapid growth , a country that has not caught up to a country may feel poor Access for free at 20 Review Questions 499 . Would the following events usually lead to capital deepening ?

Why or why not ?

10 . 11 . a . A weak economy in which businesses become reluctant to make investments in physical capital . A rise in international trade . A trend in which many more adults participate in continuing education courses through their employers and at colleges and universities . What are the advantages for economic growth ?

Would you expect capital deepening to result in diminished returns ?

Why or why not ?

Would you expect improvements in technology to result in diminished returns ?

Why or why not ?

Why does productivity growth in economies not slow down as it runs into diminishing returns from additional investments in physical capital and human capital ?

Does this show one area where the theory of diminishing returns fails to apply ?

Why or why not ?

Review Questions 13 . 14 . 15 . 16 . 17 . 18 . 19 . 20 . 21 . How did the Industrial Revolution increase the economic growth rate and income levels in the United States ?

How much should a nation be concerned if its rate of economic growth is just slower than other nations ?

How is per capita calculated differently from labor productivity ?

How do gains in labor productivity lead to gains in per capita ?

What is an aggregate production function ?

What is capital deepening ?

What do economists mean when they refer to improvements in technology ?

For a economy like the United States , what aggregate production function elements are most important in bringing about growth in per capita ?

What about a country such as Brazil ?

A country such as ?

List some arguments for and against the likelihood of convergence . Critical Thinking Questions 22 . 23 . 24 . 25 . Over the past 50 years , many countries have experienced an annual growth rate in real per capita greater than that of the United States . Some examples are China , Japan , South Korea , and . Does that mean the United States is regressing relative to other countries ?

Does that mean these countries will eventually overtake the United States in terms of the growth rate of real per capita ?

Explain . Labor and Economic Growth outlined the logic of how increased productivity is associated with increased wages . Detail a situation where this is not the case and explain why it is not . Change in labor productivity is one of the most watched international statistics of growth . Visit the Louis Federal Reserve website and the data section ( Find international comparisons of labor productivity , listed under the FRED Economic database ( Growth Rate of Total Labor Productivity ) and compare two countries in the recent past . State what you think the reasons for differences in labor productivity could be . Refer back to the Work It Out about Comparing the Economies of Two Countries and examine the data for the two countries you chose . How are they similar ?

How are they different ?

500 20 Problems 26 . 27 . 28 . 29 . 30 . 31 . Education seems to be important for human capital deepening . As people become better educated and more knowledgeable , are there limits to how much additional more education can provide ?

Why or why not ?

Describe some of the political and social that might occur when a less developed country adopts a strategy to promote labor force participation and economic growth via investment in girls education . Why is investing in girls education for growth ?

How is the concept of technology , as with the aggregate production function , different from our everyday use of the word ?

What sorts of policies can governments implement to encourage convergence ?

As technological change makes us more sedentary and food costs increase , obesity is likely . What factors do you think may limit obesity ?

Problems 32 . 33 . 34 . 35 . An economy starts off with a per capita of . How large will the per capita be if it grows at an annual rate of for 20 years ?

for 40 years ?

for 40 years ?

for 40 years ?

An economy starts off with a per capita of euros . How large will the per capita be if it grows at an annual rate of for 10 years ?

for 30 years ?

for 30 years ?

Say that the average worker in Canada has a productivity level of 30 per hour while the average worker in the United Kingdom has a productivity level of 25 per hour ( both measured in dollars ) Over the next five years , say that worker productivity in Canada grows at per year while worker productivity in the UK grows per year . After years , who will have the higher productivity level , and by how much ?

Say that the average worker in the economy is eight times as productive as an average worker in Mexico . If the productivity of workers grows at for 25 years and the productivity of Mexico workers grows at for 25 years , which country will have higher worker productivity at that point ?

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