Economics Today The Micro 17th

Edition by Roger LeRoy Miller

ISBN 0132948885 9780132948883

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Chapter 9
Global Economic Growth and Development

◼ Overview
In this chapter, economic growth, its meaning, measurement, implications, and desirability are discussed.
The major determinants of economic growth are examined. These are productivity increases, the rate of
saving, technological change, research and development, an open economy, innovation, investment in
human capital, population, and property rights. Some empirical measurements of these determinants as
they pertain to growth are presented. There is a discussion of new economic growth theory. Finally, an
introduction to development economics is presented.

◼ Learning Objectives
After studying this chapter, students should be able to
• Define economic growth.
• Recognize the importance of economic growth rates.

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84 Miller • Economics Today, Seventeenth Edition

• Explain why productivity increases are crucial for maintaining economic growth.
• Describe the fundamental determinants of economic growth.
• Understand the basis of new growth theory.
• Discuss the fundamental factors that contribute to a nation’s economic development.

◼ Outline
I. How Do We Define Economic Growth?: Increases in per capita real GDP over time. It is measured
by the rate of change of real GDP per capita per year. If there is economic growth, the production
possibilities curve will shift outward. (See Figures 9-1 and 9-2 and Table 9-1.)
A. Problems in Definition: Real standards of living can go up without any positive economic
growth when individuals are, on average, enjoying more leisure by working fewer hours, but
producing as much as before. Growth tells us nothing about the distribution of output and income.
B. Is Economic Growth Bad?: Anti-growth proponents suggest that economic growth is bad
because it raises expectations faster than income. Our measures of growth allow us to make
comparisons across countries and time and provide a serviceable measure of productivity.
(See Table 9-2.)
C. The Importance of Growth Rates: Small differences in the growth rate are important. In
50 years, $1 trillion per year becomes $4.38 trillion per year if compounded at 3 percent per
year. One percentage point more in the growth rate, i.e., to a growth rate of 4 percent, increases
the amount to $7.11 trillion. (See Table 9-3.)
1. The Rule of 70: A rule stating that the approximate number of years required for per capita
real GDP to double is equal to 70 divided by the average rate of economic growth.

II. Productivity Increases: The Heart of Economic Growth: Labor productivity is real GDP divided
by the number of workers (output per worker). Increases in labor productivity lead to increases in
the standard of living. If all resources are divided up into labor and capital, then the growth of per
capita GDP is the cumulative contribution of the growth of capital, the growth of labor, and the rate
of growth of capital and labor productivity. (See Figure 9-3.)

III. Saving: A Fundamental Determinant of Economic Growth: Higher savings rates lead to higher
living standards in the long run, other things being equal, because investment and the capital stock
will increase. To have more consumption in the future, you have to consume less today and save the
difference between your consumption and your income. (See Figure 9-4.)

IV. New Growth Theory and the Determinants of Growth: New Growth Theory examines factors
that determine why technology, research, innovation, and the like are undertaken and how they
interact.
A. Growth in Technology: The growth of the power of the personal computer is given as an
example of technological change.
B. Technology: A Separate Factor of Production: One of the major foundations of new growth
theory is that the greater the rewards, the more technological advances we will get.
C. Research and Development: Technological advance can come from R&D that develops new
materials, products, and processes. Thus, some technological advance depends on the rate of
spending on R&D, and business spending on R&D depends on expected profits. The greater the
reward, the more technological advances we will get.

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1. Patents: A 20-year monopoly on a new product or technique granted by the federal

government to an inventor. (See Figure 9-5.)
2. Positive Externalities and R&D: Some of the results of R&D spending accrue to others
who benefit without paying. An estimated 25 percent of R&D spending in the top seven
industrialized countries accrues to foreigners.
D. The Open Economy and Economic Growth: Open economies can experience higher rates of
growth than closed economies because free trade encourages a more rapid spread of technology
and industrial ideas and may give domestic industries access to a bigger market. (See Figure 9-6.)
E. Innovation and Knowledge: Innovation involves transforming an invention into something that
benefits the economy. Much innovation involves small improvements in the use of an existing
technology.
F. The Importance of Ideas and Knowledge: Past investment in capital may make it more
profitable to acquire more knowledge. There exists the possibility of an investment-knowledge
cycle where investment spurs knowledge and knowledge spurs investment. Therefore knowledge,
like capital, has to be paid for by forgoing current consumption. Knowledge can be viewed as a
store of ideas. Thus, economic growth can continue as long as we keep coming up with new ideas.
G. The Importance of Human Capital: Increases in the productivity of the labor force are a
function of increases in human capital. Human capital is at least as important as physical capital.

V. Immigration, Property Rights, and Growth: New theories of growth shed light on the impact of
immigration and property rights on the rate of growth of real GDP per capita.
A. Population and Immigration as They Affect Economic Growth: Population increases the
labor supply, technological progress by increasing the number of geniuses, and by creating new
spending that stimulates new businesses.
B. Property Rights and Entrepreneurship: The more securely property rights are assigned, the
more capital investment there will be and thus the higher will be the rate of economic growth.
VI. Economic Development: The essential issue of development economics is why some countries
grow and develop and others do not, and the policies that might help developing countries get richer.
A. Putting World Poverty into Perspective: At least one-third of the world’s population lives at
subsistence level. The official poverty level in the United States exceeds the average income of
at least one-half of the world’s population.
B. The Relationship Between Population Growth and Economic Development: World
population is expected to reach approximately 9.3 billion by the year 2050, up from 7 billion
today. Excessive population growth has been a concern ever since Malthus’s day (1798).
(See Figure 9-7.)
1. Malthus Was Proved Wrong: As population has grown, the amount of food produced as
measured by calories per person has increased. Also, the relative price of food has fallen for
more than a century.
2. Growth Leads to Smaller Families: As nations get richer, the average family size declines.
C. The Stages of Development: Agriculture to Industry to Services: Modern rich nations
went through three stages as they developed, from the dominance of agriculture to that of
manufacturing, and finally to the dominance of services. It is important that nations that wish
to develop specialize in those products in which they have a comparative advantage.
D. Keys to Economic Development
1. Establishing a System of Property Rights: The more certain property rights are, the more
capital accumulation and economic growth there will be, other things being equal.

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2. Developing an Educated Population: Developing countries can advance more rapidly if

they increase investments in education.
3. Letting “Creative Destruction” Run Its Course: “Creative destruction” occurs when new
businesses ultimately create new jobs and economic growth after first destroying old jobs,
old companies, and old industries.
4. Limiting Protectionism: Open economies experience faster economic development than
do economies that are closed to international trade.

◼ Points to Emphasize
Measuring Economic Well-Being
Economic growth is typically measured by the rate of change of real per capita GDP. While this definition
has the merit of being measurable, many economists maintain that growth rates do not really give a very
good measure of changes in economic well-being. In particular, it is frequently pointed out that such a
measure does not take into account changes in leisure, changes in the distribution of income, and in the
deterioration in the quality of life due to the growth of pollution. Yet, increases in the material well-being
of the population are what most people think of as economic growth.

The Importance of Growth Rates

The text emphasizes the difference that small economic growth rates can make over a number of years.
The use of the Rule of 70, which identifies the number of years it takes to double output, can be a very
simple way to illustrate the power of compound growth. The average U.S. annual growth rate between
1990 and 2011 was 2.4 percent. This means that per capita real GDP would double every 29 years if
that growth rate continued. If the U.S. economy was able instead to grow at China’s annual rate of
10.1 percent, per capita real GDP would double every 6.9 years.

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How to Show Economic Growth

It is easy to get a feeling for the concept of economic growth by use of the production possibility curve
shifting outward. It is the simplest way to show how society can have more of both goods.

The Importance of Property Rights in Economic Development and Growth

Economic growth will be increased if there are well-defined and enforced property rights. Economic
growth represents the sum of the expansion of the output of each firm in the economy. It is worth looking
at intellectual property rights—specifically copyright law—to examine the importance of property rights.
Copyright law was developed to allow persons who create music, write, and today create software and
movies to have the right to be the exclusive owner and seller of the right to use these works. As a result,
the music, publishing, motion picture, and software industries have flourished. The development of the
Internet and file sharing technology has affected the music industry most heavily because it has allowed
people to copy for free music that must otherwise be purchased because it is copyrighted. As a result, the
music industry experienced a dramatic decline in sales of music. Between 2000 and 2001, unit sales of
CDs decreased by 6.4 percent with a further 8.9 percent decline between 2001 and 2002. Between 2002
and 2003, unit sales of CDs decreased a further 7.1 percent. The result was a decrease in GDP originating
in the music industry at that time. The problem was that violations of the copyright laws on music are
difficult to prosecute when peer-to-peer file sharing is used. The effect on the industry of its inability to
enforce copyright protection was that it was shrinking until it found a new business model that allowed it
to once again charge for music in the late 2000s. The industry has begun recovering despite a decrease in
CD sales of about 21 percent between 2008 and 2009 (http://www.riaa.com/keystatistics.php).

The Importance of Productivity Improvements

It is essential that students understand that increases in productivity over time are what cause economic
growth and increases in living standards. In 2010 and 2011, the growth of productivity as measured by
output per hour of all persons employed in business decreased from about 3 percent per year in 2010 to
0.4 percent per year in 2011. Growth of real compensation per hour rose by 0.2 percent in 2010 and fell by
0.5 percent in 2011. Over the period 1990 to 2010, output per hour rose by about 58 percent, and real
compensation per hour rose by about 29 percent (http://www.bls.gov/home.htm).

◼ For Those Who Wish to Stress Theory

The Mathematics of Compound Growth
The Rule of 70 is an approximate way of computing the doubling time of a sum growing at any given
compound growth rate. A more precise method is to use a compound growth formula so that the amount of
growth can be computed for any period. The formula for an amount compounded annually is as follows:

Qn = Q(1 + r)n

where Qn is the quantity after n periods, Q is the initial quantity, and r is the rate of growth.

For example, if Real GNP is $5 trillion now, what will it be in two years if the rate of growth is 3 percent?

Real GDP in Year 2 = $5 (1 + 0.03)2

= 5 (1.609)
= 5.3045 trillion dollars.

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The Neoclassical Growth Model

The neoclassical growth model was initially developed by Robert M. Solow in 1956 (see Selected
References). The model shows the effects of capital accumulation and technological change and illustrates
some of the ideas presented in the chapter. The model assumes two inputs, capital (K), and labor (L), with
output (Y) being a function of these two inputs. Solow separated the effects of capital accumulation and
technological change. First, let K increase with no technological change. When the amount of capital
increases faster than the labor force, then the amount of capital per worker increases. The increased capital
per worker increases the output per worker and thus increases the real wage. Diminishing returns to capital
will decrease the real return on capital. Total output grows faster than the labor force, and living standards
rise. Investment would eventually come to a halt when the real return on capital gets too low.

In fact, the existence of technological progress increases the productivity of capital (and labor) so that
its rate of return increases. Thus, other things being equal, technological progress prevents the return on
capital from falling while real wages can continue to rise along with output.

The model also shows that the rate of investment is determined by the rate of saving. Thus, the greater is
the marginal propensity to save, the greater is the rate of investment, and the greater is the rate of growth.

Competing Economists’ Views on Growth

The issue of whether growth should be encouraged or discouraged has been one of controversy for several
decades. It is based on different value judgments concerning whether existing institutional arrangements
are best or whether they should be changed to promote or slow down economic growth. There are two
groups of economists who have different positions. Conservative economists take existing institutional
arrangements as given and argue that a “natural” rate of growth can be derived from these arrangements
(e.g., existing income distribution, tax rates on various types of income, and incentives to save and invest).
In effect they do not favor economists tinkering with whatever institutional arrangements society has
developed in the past. Liberal economists, on the other hand, have argued for both more and less growth
at different times based on their perceptions of the consequences of growth. They argue that existing
institutional arrangements that have been made by society can be changed to either increase or decrease
the rate of growth depending on its consequences.

In the mid-1960s, liberal economists were pro-growth. They felt that it was through economic growth that
minorities, the poor, and the less able would advance as the benefits “trickled down.” Governmental
policy was to be geared toward economic growth. At that time, growth was as important a goal as full
employment and price stability. Conservative economists argued that the growth rate for a given economy
was determined by millions of people making individual choices as to how much to consume and how
much to save, given existing incentives and institutional arrangements. Different societies with different
“rates of time preference” and incentive systems grow at different rates, called “natural rates.” In particular,
those countries in which the populace was future oriented would experience relatively high growth
rates, while present-oriented societies would grow more slowly. Conservative economists felt that for
government to take measures to increase the growth rate more rapidly than the natural rate would cause
community economic well-being to fall. People would be forced to trade less current consumption for
more future consumption, something they would not do voluntarily.

Currently, liberal economists are anti-growth and want governmental policy geared to reducing the growth
rate (see Mishan, Schumacher, and Thurow as examples). Their reasons are the problems of overpopulation
and pollution. Increased economic growth and increased population lead to increases in the quantities of
resources used to produce goods and services. These economists argue that not only are nonrenewable
resources being depleted rapidly, but also an increased use of resources implies increased pollution. Nature’s

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ability to cleanse itself is being impaired. Since matter can neither be created nor destroyed, the waste
resulting from increased production and consumption must go into the environment.

Conservative economists maintain that we need not promote lower population growth or economic growth
(see Simon and Beckerman as examples). First, they maintain that population and pollution are separate
issues because decreased population is neither a necessary nor a sufficient condition for decreased pollution.
Second, the results of relative price changes will be that scarcer resources will be conserved, fewer outputs
using scarcer resources will be purchased, and input and output substitutes will arise as a result of market
processes. Given free markets, economic value will be maximized, not physical quantities of goods.

Determinants of Economic Growth

The book makes it clear that no single factor is sufficient to generate economic growth. It is clear, however,
that when technological change is embodied in both human and nonhuman capital, a major prerequisite for
growth has occurred. When this capital is put to work in a system that encourages its use and provides an
incentive structure to further develop and invest, then economic growth is encouraged. Access to raw
materials is important, but outright possession of them is not (e.g., Japan). The ex-Soviet system had large
amounts of capital, labor, and raw materials but had economic stagnation prior to its collapse.

To get more capital requires saving. Growth will not occur without saving. The higher the rate of saving,
other things being equal, the more resources are released from producing goods for current consumption
and more investment can occur in both human and non-human capital.

◼ Further Questions for Class Discussion

1. Why can growth only occur if current consumption is sacrificed? A good way of approaching this issue
is to examine the sacrifice of current income (and thus current consumption) by college students in
order to acquire human capital. By not consuming as much now, they are acquiring education and
skills that will (hopefully) make them more productive and thus able to earn a higher income in the
future. Society also will have more output in the future if there is investment in this human capital,
since the labor force will be more productive.

2. What kinds of government policies could promote economic growth? Government funding of basic
research could result in new discoveries that could allow for new innovation in products and technology.
Government taxation of income from saving at a lower rate than other income or allowing deferral
of taxes on savings, e.g., IRAs for everyone, would encourage saving, thus releasing resources for
investment. A reduced corporate tax rate or some kind of investment tax credit would increase
investment.

3. Ask students why less-developed countries are less likely to allow Schumpeter’s “creative destruction”
to occur as compared to the developed economies. An obvious point is that such economies are
already poor, and the decline and possible loss of a major source of employment would be much
more disruptive than would be the case in a large, diversified, developed economy. There are thus
more likely to be undesirable political consequences in a less-developed economy.

4. In recent years, the federal and state governments have reduced the percent of higher education costs
that they will pay, thus increasing the percentage of costs borne by students and their families. What
is the likely effect on the future rate of growth in the United States? As the percentage of costs paid
by students and their families increases, fewer lower-income students will be able to get a college
education. The effect will be a reduction in investment in human capital. Other things constant, the
rate of economic growth will decrease.

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5. Suppose that a country finds that its rate of economic growth has fallen from 3 percent to 2 percent
per year. How many more years would it take for per capita real GDP to double at the lower growth
rate? (Hint: Rule of 70.) Using a growth rate of 2 percent and the Rule of 70, real GDP would double
in approximately 35 years (70/the average rate of growth or 70/2). At 3 percent, real per capita GDP
would double in approximately 23 years (70/3 = 23.3). Thus real GDP per capita would take about
11.7 (35 − 23.3) years more to double if the growth rate were to decrease from 3 percent to 2 percent.

6. As a result of the Great Recession in 2007–2009 the U.S. household saving rate increased from
2.1 percent of disposable personal income to in 2006 to 6.2 percent in the second quarter of 2010.
If household saving were the only source of savings in the economy, explain what would happen to
real GDP per capita and the rate of economic growth ceteris paribus if the new 2010 saving rate were
to continue? An increase in savings would imply an increase in net investment. The result would be
an increase in per capita real GDP, and the rate of growth would increase.

◼ Answers to Questions for Critical Analysis

Growth Rates Around the World (p. 189)
One would expect that growth rates could be higher in poorer countries because the same absolute increase
in real GDP would be a larger percentage of a poorer country’s real GDP than it would be of a rich
country’s real GDP.

Gauging the Future Impact of 1-Percentage-Point Growth Drop (p. 191)

Because of compounding, the effect of any given percentage reduction in the rate of economic growth will be
compounded from one year to the next. As a result, the cumulated reduction over a number of years will be
larger than the cumulated reduction without the compounding effect.

China Rethinks Its Openness to Merchandise Trade (p. 197)

Just as free trade encourages a more rapid spread of technology and industrial ideas, the recent restrictions
on imports of the latest digital devices have helped to isolate China’s domestic industries from global
technological progress.

The Quest for Invisibility Promises Waves of Innovation (p. 197)

Innovation is the transformation of an invention into something that is useful to humans. The invisibility
research so far has resulted in the invention of metamaterials, but it has not yielded anything that is useful to
humans.

Ireland Experiences Yet Another Big “Brain Drain” (p. 198)

The Irish government could implement policies to provide incentives, such as wage bonuses and tax cuts, for
Ireland’s skilled workers to remain in the nation.

◼ You Are There

Implementing a New Patent Framework to Promote Innovation (p. 204)
1. An invention is simply the creation of something new. It is not necessarily useful to humans without
innovation, which benefits the economy by lowering production costs or by producing new goods and
services. Hence, inventions alone are insufficient to boost economic growth.

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2. Markets help to determine whether inventions translate into long-lasting innovations by providing
financial rewards to those inventions that result in new goods and services that consumers value
highly.

◼ Issues and Applications

Does a Household Shift to Thrift Signal a Growth Recovery? (pp. 204–205)
1. Saving is the amount of disposable personal income that is not spent on goods and services. A nation
or household borrows when its spending on goods and services exceeds its disposable personal
income, meaning that saving is negative.

2. When residents of the United States are overall net borrowers, residents in foreign countries must be
funding the borrowing from U.S. residents.

◼ Answers to Even-Numbered Problems

9-2. The nation’s stock of capital goods will shrink because of depreciation, so its rate of economic
growth will be negative.

9-4. A: $5,500 per capita; B: $3,000 per capita; C: $14,000 per capita

9-6. a. X; $23,153
b. Z; $22,945
c. Y; $25,472

9-8. Approximately 40 years

9-10. In Mozambique, in 10 years the typical resident’s annual real GDP per capita will equal to $3,000 ×
1.34 = $4,020. In China, a typical resident’s real GDP per capita will equal to $3,000 × 2.16 =
$6,480, which is $2,460 per year greater than in Mozambique.

9-12. The nation’s per capita real GDP was $4,000 in 2012 and 2013. Its rate of economic growth was
zero percent.

9-14. zero percent

9-16. a. New growth theory emphasizes the importance of human capital as a key facet of economic
growth. Brazil’s relatively lower literacy rate suggests that it is lagging in human capital
development and hence potential for longer-term economic growth.
b. Policies might include programs narrowly focused on promoting a higher literacy rate and
broadly focused on a greater average educational attainment by its residents.

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◼ Selected References
Adelman, Morris A. et al., No Time to Confuse, San Francisco Institute for Contemporary Studies, 1975.
Beckerman, Wilfred, In Defense of Economic Growth, London: Jonathan Cape, 1974.
Denison, E.F., Accounting for Slower Growth, Washington, D.C.: The Brookings Institute, 1979.
Kuznets, Simon, Six Lectures on Economic Growth, New York: Free Press, 1959.
Mishan, E.J., The Cost of Economic Growth, New York: Praeger, 1967.
Olson, Mancur and Hans H. Landsberg, eds., The No-Growth Society, New York: W.W. Norton and
Company, 1973.
Phelps, Edmund S., ed., The Goal of Economic Growth, New York: Norton, 1962.
Schumacher, E.F., Small Is Beautiful, New York: Harper and Row, 1973.
Schumpeter, Joseph A., Theory of Economic Development, Cambridge: Harvard University Press, 1934.
Simon, Julian L., “Resources, Population, and Environment: An Oversupply of False Bad News,” Science,
June 27, 1980.
Simon, Julian L., The Ultimate Resource, Princeton, NJ: Princeton University Press, 1980.
Solow, Robert M., “A Contribution to the Theory of Economic Growth,” The Quarterly Journal of
Economics, Vol. LXX, February 1956, pp. 65–94.
Thurow, Lester C., The Zero Sum Society, New York: Basic Books, 1980.

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