Macroeconomics

Week 10

Economic Growth: Part II

 Income and Happiness

Easterlin paradox: Happiness increases with income BUT once basic needs are
satisfied, higher income per person does not increase happiness, and the level of
income relative to others, rather than the absolute level of income, matters.
Emotional happiness vs. Life satisfaction.

Source: Betsey Stevenson and Justin Wolfers, Wharton School at the University of Pennsylvania.
 Growth in Rich Countries since 1950

Growth rate of GDP per person since 1950 versus GDP

per person in 1950
(OECD countries)

Convergence:
Countries with
lower levels of
output per
person in 1950
have typically
grown faster

(the relation is far from Source: Penn Tables, http://cid.econ.ucdavis.edu/pwt.html.

perfect – see Portugal or

Luxembourg)
 Convergence since the 1990s

Speed of
convergence
differs significantly
across countries

See:
https://www.economist.com/news/briefing
/21616891-ten-years-ago-developing-
economies-were-catching-up-developed-
ones-remarkably-quickly-it
 Growth across millenia

• Has output per person in the currently rich economies always

grown at rates similar to the growth rates of the last century?

• No. Difficult to reconstruct exact growth rates as we go back in

time, but there’s consensus regarding past 2000 years

• From the end of the Roman Empire to roughly year 1500, there
was essentially no growth of output per person in Europe

• Although there was some output growth, it was limited and

proportional to population increase – hence, constant output
per person - because most workers were in agriculture with little
technological progress
 Growth across millenia

• Europe was in a Malthusian trap or Malthusian era

with stagnation of output per person

• Term comes after Thomas Malthus, an English

economist of the 18th century, who argued that the
proportional increase in output and population was not
a coincidence:
any increase in output would lead to a decrease in
mortality, leading to an increase in population until
output per person was back to its initial level
 Growth across millenia

• Eventually, Europe escaped this trap… between 1500-1700,

growth of output per person was positive, even though very
small: 0.1% / year

• Rates increased with the Industrial Revolution, from the second

half of 18th century
• Still from 1820 to 1950 the growth rate of output per person in
the United States was still only 1.5% per year

• On the scale of human history sustained growth of output per

person – especially the high growth rates seen since 1950 – is a
recent phenomenon
 Growth across countries

• For much of the first millennium and until 15th century,

China probably had the world’s highest level of output per
capita

• Then, around the period of “discoveries” and the

Renaissance leadership moved to Europe: first, to the
cities of northern Italy, then to countries involved in
shipping and colonisation of West Africa and the Americas
(Portugal, Spain, Britain, France, Holland etc)

• Until the 19th century, differences across countries were

typically much smaller than today; only after that
economies started “diverging”
 Growth across countries

Growth rate of GDP per person since 1960, versus GDP

per person in 1960
(2005 dollars; 85 countries)
Convergence?

There is no clear
relation between the
growth rate of output
since 1960 and the level
of output per person in
1960

Source: Penn Tables, http://cid.econ.ucdavis. edu/pwt.html.

 Growth across countries

• For the OECD countries, there is clear evidence of

convergence, as we saw earlier

• Convergence is also visible for many Asian countries,

especially for those with high growth rates
(particularly 1960-1990 when grew at over 7% year),
called the four tigers—Singapore, Taiwan, Hong Kong,
and South Korea
• More recently, the main driver (in Asia) has been
China both because of its size and fast growth
 Economic Growth: a primer

• To think about growth, economists use a framework

developed originally by Robert Solow in the 1950s

• Aggregate production function F sets out relation

between aggregate output and inputs

where Y is output, K is capital, and N is labour

• This function F tells us how much output is produced for

given quantities of capital and labour
 Economic Growth: a primer
• The function F depends on the state of technology: a
country with a more advanced technology will produce more
output from the same quantities of capital and labour than will an
economy with a primitive technology

• We assume Constant Returns to Scale:

Instead of:
• Decreasing returns to scale: given increase in K and N lead to less than
proportional increase in Y
• Increasing returns to scale: increase in K and N lead to proportionally
larger increase in Y
 Economic Growth: a primer
• What if only 1 input (K or N) changes?
What happens to Y?
• This is what we call return to a factor
• If K increases and N remains fixed, output (Y) will
increase but by smaller and smaller amounts -->
decreasing returns to capital
• What does this imply about the relationship
between labour and capital? Can you think of
any recent changes in this?
• (Same logic applies to returns to labour)
 Economic Growth: a primer

• The production function we defined above + the

assumption of constant returns to scale imply a
simple relation between output per worker (Y/N) and
capital per worker (K/N):

• The amount of output per worker depends on the

amount of capital per worker
 Economic Growth: a primer

The relation between K/N and

Y/N is shown by the graph:
- It is a positive relation,
thus the positive slope of
the line
(first derivative > 0)

- There are decreasing

returns to capital per
worker: increases in
capital per worker lead to
smaller and smaller
increases in output per
worker – thus, the
decreasing slope of the
line
(second derivative < 0)
 Economic Growth: a primer

Movements along the curve vs. movements (shifts) of the curve

• Increases (decreases) in capital per worker:

movements along the production function

• Improvements in the state of technology: Shifts (up)

of the production function

➢ Growth comes from capital accumulation (a higher

saving rate) and technological progress (the
improvement in the state of technology)
 Economic Growth: a primer

An improvement in
technology shifts
the production
function up,
leading to an
increase in output
per worker for a
given level of
capital per worker