Production and Growth

• Chapter 25: Production and Growth
  • 25-1: Economic Growth Around the World
  • 25-2: Productivity: Its Role and Determinants
  • 25-3: Economic Growth and Public Policy

Chapter 25: Production and Growth

• Different countries have different levels of productivity and different GDPs
• This chapter focuses on ways that these statistics can vary from country to country

25-1: Economic Growth Around the World

• Consider the following table:
• Clearly, there are differences in GDP between various countries, but a few things stand out
  • Countries don’t always stay on top: The UK was the richest country in the world but is now behind US, Canada, and Germany
  • Countries don’t always stay poor: Japan, China, and Brazil have experienced incredible growth, taking them for poorer nations to middle-income/rich ones
• This table shows that things can vary greatly, but what drives these changes?

25-2: Productivity: Its Role and Determinants

Why Productivity Is So Important

• Consider an isolated economy that must sustain itself through its production and no foreign trade
• The higher said economy’s productivity is, the higher its quality of life
  • More goods produced means more abundance which means free time, specialization, etc.
• Note that an economy’s GDP measures both total income and total expenditure, so GDP is often a good measure of quality of life for economies
  • Higher GDP means more production

How Productivity Is Determined

• Different factors can affect an economy’s ability to produce
• Physical Capital
  • Workers are more productive if given tools to work with
  • The stock of equipment and structures used to produce goods and services is called physical capital, or often just capital
  • Consider a bakery; the baker requires a rolling pin, baking sheets, an oven, etc. to efficiently produce baked goods
    • These factors of production are included in physical capital
  • Physical capital can also be used to create more physical capital; a miner mines ore to create nails to build a house
• Human Capital
  • Human capital refers to the knowledge and skills worker gain through education, training, and experience
  • A better quality of human capital means a higher productivity
  • Producing human capital requires labor and time, such as teachers, libraries, study, etc.
• Natural Resources
  • Natural resources refers to inputs into production that are found in nature, such as water, wood, land, etc.
    • Renewable resources include forests, animal husbandry, etc.
    • Nonrenewable resources include oil and minerals
  • Differences in natural resources are a big factor for some of the differences in productivity
    • US has great farmland, Middle East has a lot of oil, etc.
  • Some countries without many natural resources, like Japan, can thrive through international trade
• Technological Knowledge
  • Technological knowledge refers to the understanding of the most efficient ways to produce goods and services
  • Two types
    • Common knowledge, such as the invention of Henry Ford’s assembly line; can be employed by everyone
    • Proprietary, such as Coca-Cola’s secret recipe; often patented and only used by the company who discovered it
  • “Technological knowledge is the quality of society’s textbooks, whereas human capital is the amount of time that the population has spent reading them.

25-3: Economic Growth and Public Policy

• The following section details different policies governments can adopt to improve productivity

Saving and Investment

• Physical capital is a produced factor of production, so devoting more resources towards it can help improve future production
  • Consider a country that uses all of its labor to make food; its production remains stagnant because it doesn’t improve
  • If said country used half of its labor to make tools, then in the following year, it would be able to produce more food using the new tools
• In general, saving and investment can enocourage growth and improve an economy’s standard of living in the long run

Diminishing Returns and the Catch-Up Effect

• If a government passes a new saving rate, how long will they enjoy an increased rate of growth?
• Economists believe that (the saving of) physical capital is subject to diminishing returns, so the more you have, the less benefit you get from saving more
  • This property is also known as the diminishing marginal product of capital
  • Graph:
• In the long run, a higher saving rate leads to a higher level of productivity and income but no to higher growth in those areas
  • According to economic studies, the increased growth from a higher saving rate can last for decades
• The presence of diminishing returns leads to the catch-up effect where smaller countries can grow at a faster rate than more established ones
  • For example, the US and South Korea both had the same saving rate in 1960, but South Korea grew by a lot more due to its smaller size
• Though the catch-up effect leads to more rapid growth, bigger countries will remain bigger because they had more capital to start with

Investment from Abroad

• Two types of foreign investment
  • Foreign direct investment occurs when a capital investment is owned and operated by a foreign entity
    • ex: Ford Motor Company creates a new factory in Mexico
  • Foreign portfolio investment occurs when a capital investment is owned by a foreign entity but operated by domestic residents
    • ex: said factory is run by Mexicans
  • Both types increase the stock of capital in Mexico
• Foreign investments happen because investors expect a return on their money, so the profit made from a domestic factory might be split between foreign investors and residents
  • Still, these investments increase the GDP of the country the factory is in
  • The GDP measures production and income while the GNP measures only income, so the GDP will increase by more than the GNP due to the cut investors take
• Investment from abroad is beneficial because it increases productivity and allows poorer countries to understand better technologies
• The World Bank encourages investment from abroad into underdeveloped countries to promote stability

Education

• Schooling can increase one’s wages and standard of living considerably, so government policy encouraging schooling can increase the standard of living
• Education incurs an opportunity cost; students could have used the time spent in school working in the work force
• Some economists argue that human capital is especially important because it confers positive externalities such as the production of new technologies
• Poorer countries face the issue of brain drain, or the common practice of educated workers emigrating to richer ones for better wages and a higher standard of living
  • Said workers might not come back to their countries of origin to improve its GDP

Health and Nutrition

• Human capital can also refer to public health
• Healthier workers are more productive compared to undernourished ones
  • For instance, height has been correlated with higher productivity, and nutrition is a direct cause of height
• The link between health and wealth creates a vicious cycle; poorer nations have lower productivity and thus less healthy workers which leads to lower productivity
  • The opposite also occurs; wealthier nations have higher productivity and thus healthier workers which leads to higher productivity

Property Rights and Political Stability

• Production relies on the interactions between millions of individuals and firms, and the economy must coordinate said interactions through market prices
• For pricing to work, economies must have a system of property righs which encourage trade and leads to set prices
  • If property rights don’t exist, then everyone would steal, thus the justice system enforces laws and contracts
• Underdeveloped countries often lack the ability to enforce property rights, leading to fraud, corruption, and crime
  • Political instability threatens the existence of property rights, as it is unclear whether or not said rights can be enforced
• Politically stable countries with good governments thus have higher productivity

Free Trade

• Some countries try to use inward-oriented policies which attempt to increase productivity through a lack of interaction with foreign countries
  • Supporters of said policies advance the infant-industry argument and are often distrusting of foreigners
• Most economists believe that poorer countries are better off using outward-oriented policies which can act as a sort of technology
  • If a country has an abundance of wheat and can trade that wheat for computers, they effectively have technology which turns wheat into computers
  • Countries that encourage free trade thus experience a high rate of growth equivalent to a technological advance
• Countries with inward-oriented policies must produce everything (food, textiles, technology, etc) by itself, leading to inefficiency
• Countries with seaports and easy access to trade often prosper more than countries without them

Research and Development

• Advances in technological knowledge is a big reason why the quality of life today is better than ever
• Technological advances often come from private firms, but said advances are, to a large extent, a public good that can be used by many people
• Because of this, the US government encourages the research and spread of new technologies, as seen in programs such as NASA
• The patent system encourages research and development for financial gain

Population Growth

• The effects of population growth have been long debated
  • Larger populations lead to more production because of the increased amount of labor
  • Larger populations lead to higher consumption which can decrease the standard of living at large
• Population growth also affects factors of production in other ways
• Stretching Natural Resources
  • Thomas Malthus argued that population growth would outpace the production of food, thus leading to “misery and vice”
  • Malthus’ theory was incorrect largely due to his failure to account for technological advances in food production
• Diluting the Capital Stock
  • Some theorize that high population growth reduces the GDP per worker because more workers causes capital, both physical and human, to be spread more thinly
  • This is most prevalent in poorer countries where the population growth is 3% compared to 1% in developed countries like the US
    • Some countries, like China, forced population growth down through their one-child policy
  • Income equality can encourage population growth to decrease due to the increased opportunity cost of bearing a child
• Promoting Technological Progress
  • The more people there are, the more geniuses, engineers, scientists, etc. there are to help improve technology
    • This theory has been supported by articles and studies in the past
    • Larger populations grow at a faster rate due to the discovery of technological advancements