Long-Run Economic Growth

Introduction

Long-run economic growth is a central topic in macroeconomics, as it determines the improvement of living standards over time. Economic growth is closely linked to health, wealth, and overall well-being. For example, higher GDP per capita is associated with lower child mortality rates, demonstrating the importance of economic development for societal outcomes.

• Economic growth refers to the sustained increase in a country's output of goods and services (real GDP) over time.

• Health and wealth are positively correlated: wealthier countries tend to have better health outcomes.

• Key question: What factors explain why some countries are richer and grow faster than others?

Incomes and Growth Around the World

There are significant differences in income levels and growth rates across countries. These differences have profound implications for living standards and development.

• Countries vary widely in GDP per capita (a measure of average income per person).

• Growth rates also differ, affecting how quickly living standards improve.

Example Table: GDP per Capita and Growth Rates (Selected Countries)

Additional info: This table illustrates the wide disparities in both income and growth rates across nations.

Key Questions in Economic Growth

• Why are some countries richer than others?

• Why do some countries grow quickly while others remain in poverty?

• What policies can help raise growth rates and improve long-run living standards?

Determinants of Productivity and Growth

Productivity

Productivity is the most important determinant of a country's standard of living. It measures the average output produced per unit of labor input.

• Productivity = output per worker = , where:

  • = real GDP (total output produced)

  • = quantity of labor (number of workers or hours worked)

• Higher productivity leads to higher incomes and improved living standards.

Why Productivity Is So Important

• When workers are more productive, real GDP and incomes are higher.

• Rapid productivity growth leads to rapid improvements in living standards.

• Understanding the determinants of productivity is key to understanding economic growth.

Factors Affecting Productivity

• Physical Capital per Worker (): The stock of equipment and structures used to produce goods and services. More capital per worker increases productivity.

• Human Capital per Worker (): The knowledge and skills acquired through education, training, and experience. Higher human capital per worker raises productivity.

• Technological Knowledge: Society's understanding of the best ways to produce goods and services. Technological progress boosts productivity by enabling more output from the same resources.

Formulas:

• Productivity:

• Physical capital per worker:

• Human capital per worker:

Economic Growth and Public Policy

Saving and Investment

Increasing the stock of physical capital requires investment, which is funded by saving. There is a tradeoff between current consumption and future consumption: saving more today allows for more investment and higher future output.

• Producing more capital goods requires reducing current consumption.

• Higher saving leads to more resources for investment, boosting future productivity.

Investment from Abroad

• Foreign Direct Investment (FDI): Capital investment owned and operated by a foreign entity (e.g., a foreign company building a factory).

• Foreign Portfolio Investment: Investment financed with foreign money but operated by domestic residents (e.g., foreigners buying stocks or bonds).

• International organizations like the World Bank and IMF help channel investment to developing countries.

Education

Investment in human capital, such as education and training, raises worker productivity and future incomes. However, it involves a tradeoff: time spent in school means forgoing current earnings for higher future wages.

• Each additional year of schooling can significantly increase a worker's wage (e.g., by about 10% in the U.S.).

• Public policies such as public schools and subsidized loans can promote education.

Institutions and Incentives

Institutions are the formal and informal rules that shape economic incentives. Good institutions promote growth by protecting property rights, ensuring political stability, and maintaining honest government and a dependable legal system.

• Property rights and rule of law are essential for investment and innovation.

• Corruption and political instability undermine growth.

Example Table: Corruption Perception Index (Selected Countries)

Additional info: Countries with less corruption tend to have higher growth and better living standards.

Trade Policy

• Inward-oriented policies (e.g., tariffs, restrictions on foreign investment) aim to protect domestic industries but often hinder growth.

• Outward-oriented policies (e.g., free trade, open investment) promote integration with the world economy and are associated with higher growth rates.

• Trade increases productivity by allowing countries to specialize and benefit from comparative advantage.

Research and Development (R&D)

Technological progress is the main driver of long-run growth. Knowledge is a public good, so policies that promote R&D can have widespread benefits.

• Patent laws, tax incentives, and grants for research encourage innovation.

• Government support for basic research at universities is also important.

Summary Table: Determinants of Long-Run Economic Growth

Discussion Example

Which policies are most effective at boosting growth and living standards in poor countries?

• Tax incentives for investment (local and foreign)

• Cash payments for school attendance

• Crackdown on government corruption

• Allowing free trade

• Restricting imports (generally not effective)

Additional info: Policies that promote investment, education, good governance, and openness to trade are generally most effective for long-run growth.