Lesson 1

Week 2
 MODERN ECONOMIC GROWTH

• There are two ways to increase output over time:

Increase inputs (more quantity) or to increase
productivity (efficiency), the ratio of output to input.
• Labour productivity:
• Is defined as real economic output per labour hour. Or
output per worker O/L
• Labour productivity, in turn, depends on the
endowment of capital per worker K/L as in the British
Industrial Revolution
• And of course, of the endowment of skills per worker:
Human capital
 M O D E R N E C O N O M I C G ROW T H

INVESTMENT

25

20

Investment

15

Savings
10
PERCENT GDP

5 INVESTMENT

SAVINGS

0
1000 3000 5000 7000 9000 11000

GDP PER HEAD (US $ 1990 PPP)

 Savings = Household income that hasn’t been spent
Investment = Corporate purchases of capital goods (plant, equipment, etc)

The role of the financial sector is to make funds saved by households

available for firms to borrow for investment activities

Households save Firms access these

their income by funds by taking out
opening savings loans, issuing stocks
accounts, buying and bonds, etc. and
stocks and bonds, use the funds for
etc investment activities

I
=i
L
Investment
per capita
 MODERN ECONOMIC GRWOTH: FOREIGN
TRADE

• Over the last couple of centuries, the world

economy has experienced sustained economic
growth.
• Over the same period, this economic growth has
been accompanied by even faster growth in global
trade.
 MODERN ECONOMIC GROWTH: FOREIGN
TRADE

• Gains from trade

• If two countries have comparative advantages
in the production of something, then there are
gains from trade.
• World output rises because the same resources
are used to make more goods than without trade.
• Example: exports of (frozen)beef from Argentina
to the UK in the early 20th century.
• Who gains and who loses?
• The efficiency gains from trade are not generally
equally shared by everyone.
 MODERN ECONOMIC GROWTH: FOREIGN
TRADE

• Tariffs:
• Tariffs prevent countries from following their
comparative advantage.
• Why? Tariffs change the price of imported
goods.
• Tariffs are a fixed payment per unit or a
proportion of the price of the imported good.
• Ad valorem tariff.
• Tariffs are revenue for the government.
• Fiscal tariffs vs protective tariffs
 MODERN ECONOMIC
GROWTH: FOREIGN TRADE

• The ‘Transport Revolution’ that

takes place in the 19th century
allows for an increase in market
size and to take advantage of
increasing returns to scale.

• Growth of income; demand go

up → national market +
international market.
 MODERN ECONOMIC GROWTH
• Transaction costs
• Economic development means a continuous
reduction in the cost of making deals, including
making payments.
• For example, the cost of raising government
revenue was initially very high.
• Government did not have information about
income and wealth to collect fair taxes: Spain in
the 19th century
• Cost to enforce contracts, cost of information….
 MODERN ECONOMIC GROWTH

• Catching up and social capability:

• Important concepts in economic history.
• Explain why (some) backward countries can grow at a faster rate than
advanced countries.
• It relates levels of GDP (at year 1) and rates of growth between (years
1 and X)
• Social capability includes human capital, the nature of the government,
respect for the rule of law, clear rules of the game…
• Only democratic governments have the social capability to increase
total factor productivity? NO.
• Think about China or Franco’s Spain during the 1950sa and 1960s.
 BASIC DIFFERENCES BETWEEN PRE -
INDUSTRIAL AND MODERN ECONOMIC GROWTH

• Modern economic growth:

• More than GDP growth
• Well-being of the population
• Life expectancy (related to infant mortality)
• Education
• Consumption
• Quality of goods and services
• More leisure time
• Rising living standards
EL CRECIMIENTO ECONOMICO EN
PERSPECTIVA HISTORICA
 RETIREMENT IS POSIBLE
WHEN PEOPLE GET RICHER
WHAT MAKES GROWTH MORE LIKELY?

• Reliable methods of payment +

Financial system
• High quality human capital
• A large market.
• Favourable international institutions
• Low barriers to trade
• Favourable institutions: the rule of law
 MODERN ECONOMIC GROWTH

“a sustained increase in income per capita or

per worker, most often accompanied by an
increase in population and usually by
structural changes”

(Simon Kuznets, 1966)

 THE ECONOMY BEFORE ECONOMIC
GROWTH

• Malthusian Model
• The model establishes a functional relation between
the size of the population and the living standards
(measured with real wages)
• Malthusian trap
• Living standards were determined by the size of the
population,
 W

Real
Wages Living Standards

0 1000
Population