Long-Run Economic Growth: Sources and Policies

Introduction to Economic Growth

Economic growth refers to the sustained increase in a country's output of goods and services, typically measured as real GDP per capita. Understanding the sources and policies that drive long-run economic growth is essential for explaining differences in living standards across countries and over time.

• Key Point: Economic growth is not inevitable; history has seen long periods of stagnation.

• Key Point: The goal is to develop a model of economic growth to explain why some countries grow faster than others.

• Example: The Industrial Revolution marked the beginning of sustained economic growth in England around 1750.

Economic Growth Over Time and Around the World

Historical Trends in Economic Growth

For most of human history, there was little to no sustained economic growth. Significant increases in living standards only began with the Industrial Revolution.

• Key Point: Before the Middle Ages, global GDP per capita remained around $150 (2021 dollars).

• Key Point: The Industrial Revolution introduced mechanical power, leading to long-run growth.

• Example: England, the United States, France, and Germany experienced rapid growth after adopting new technologies.

Why Did the Industrial Revolution Begin in England?

Institutional changes, such as the protection of property rights after the Glorious Revolution of 1688, encouraged investment and innovation.

• Key Point: Independent courts and parliamentary control over government increased entrepreneurs' willingness to invest.

Growth Rates and Living Standards

Small differences in annual growth rates can lead to large differences in living standards over decades.

• Key Point: A 1.7% growth rate over 50 years leads to a 132% increase in real GDP per capita; a 2.3% rate leads to a 212% increase.

• Key Point: Slow growth results in persistent poverty and lower life expectancy.

Income Differences Across Countries

Economists classify countries as high-income (industrialized), developing (low-income), and newly industrializing countries.

• Key Point: GDP per capita varies widely, from over $100,000 in Monaco to less than $300 in Burundi (2020).

• Key Point: Non-income factors like health and education also contribute to living standards.

What Determines How Fast Economies Grow?

The Economic Growth Model

The economic growth model explains long-run growth in real GDP per capita through labor productivity, capital accumulation, and technological change.

• Key Point: Labor productivity is the quantity of goods and services produced per hour of work.

• Key Point: Main factors: quantity of capital and level of technology.

• Definition: Technological change is an increase in output from a given quantity of inputs.

Sources of Technological Change

• Better machinery and equipment (e.g., steam engine, computers).

• Increases in human capital (education, training, experience).

• Improved organization and management (e.g., just-in-time production).

The Per-Worker Production Function

The per-worker production function shows the relationship between output per worker and capital per worker, holding technology constant.

• Key Point: Initial increases in capital are highly effective; subsequent increases face diminishing returns.

• Formula: where is output, is capital, is labor, and is technology.

Role of Technological Change

• Key Point: Technological change can overcome diminishing returns to capital and is essential for sustained growth.

• Example: Countries with low capital benefit more from capital increases; those with high capital need technological change for further growth.

Case Study: The Soviet Union

• Key Point: Focused on capital accumulation but lacked incentives for innovation, leading to stagnation.

• Key Point: Diminishing returns and lack of technological progress slowed growth.

New Growth Theory

Endogenous Technological Change

New growth theory, developed by Paul Romer, emphasizes that technological change is driven by economic incentives and market forces.

• Key Point: Knowledge capital is a key determinant of growth and is nonrival and nonexcludable (a public good).

• Key Point: Accumulation of knowledge capital leads to increasing returns at the economy level.

Government's Role in Knowledge Capital

• Protecting intellectual property (patents, copyrights).

• Supporting research and development (grants, tax incentives).

• Subsidizing education (public funding for schools and training).

Creative Destruction and Entrepreneurship

Schumpeter's Model

Joseph Schumpeter argued that economic growth is driven by entrepreneurs introducing new products and processes, which replace older ones in a process called creative destruction.

• Key Point: Innovation destroys old industries but creates new opportunities and higher living standards.

• Example: Automobiles replaced horse-drawn carriages; Blockbuster was replaced by Netflix.

Economic Growth in Canada

Trends in Canadian Growth

Canada's growth rates have fluctuated due to changes in productivity, technological innovation, and investment.

• Key Point: Growth accelerated until the 1970s, slowed from 1974-1995, picked up in the mid-1990s, and slowed again after 2006.

• Key Point: Information technology was a major driver from 1996-2020.

Debate on Future Growth

• Optimists: Productivity is higher than measured; growth will remain strong.

• Pessimists: Easy gains from IT are exhausted; future growth will be low.

• Measurement Issues: Service output and consumer surplus are hard to capture in GDP statistics.

Why Isn't the Whole World Rich?

The Catch-Up Effect

The economic growth model predicts that poorer countries should grow faster than richer ones due to higher returns on capital and available technology.

• Key Point: Some countries have caught up (e.g., South Korea), but many have not.

• Key Point: High-income countries have stopped catching up to the U.S. due to labor market flexibility, efficient financial systems, and access to capital.

Barriers to Growth in Low-Income Countries

• Failure to enforce the rule of law (property rights, contracts).

• Wars and revolutions (political instability).

• Poor public education and health (low productivity).

• Low rates of saving and investment (vicious cycle).

Role of Globalization

Globalization, through foreign direct and portfolio investment, can help low-income countries escape the cycle of low savings and investment.

• Key Point: Countries open to trade and investment have experienced higher growth rates.

Growth Policies

Government Policies to Foster Growth

• Enhancing property rights and rule of law (independent courts, anti-corruption).

• Improving health and education (public investment, preventing brain drain).

• Promoting technological change (facilitating access to technology, encouraging FDI).

• Promoting savings and investment (tax incentives, secure financial systems).

Case Studies

• China: Rapid growth due to capital investment and transition to market economy, but faces diminishing returns and demographic challenges.

• Sub-Saharan Africa: Growth requires improved governance, political stability, and diversified investment.

Is Economic Growth Good or Bad?

Debate on Growth

While economic growth is generally beneficial, especially for low-income countries, concerns exist about environmental impact, resource depletion, and cultural change.

• Key Point: Most arguments against growth are normative; economics can inform but not resolve these debates.

Common Misconceptions to Avoid

• High growth rates do not guarantee high living standards.

• Short-term growth does not lead to sustained improvements.

• No single variable explains all growth differences.

Table: Effects of Different Growth Rates on Living Standards

Additional info: Table illustrates how small differences in annual growth rates compound to large differences in living standards over time.