Economic Growth

The Facts
of Growth
CHAPTER 10
CHAPTER10
Prepared by:
Fernando Quijano and Yvonn Quijano
© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard

Chapter 10: The Facts of Growth The Facts of Growth
We now turn from the determination of output in

the short and medium run—where fluctuations
dominate—to the determination of output in the
long run—where growth dominates.
Growth is the steady increase in aggregate
output over time.
© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard 2 of 30

Growth in Rich
10-1
Countries Since 1950
Chapter 10: The Facts of Growth
Figure 10 - 1
U.S. GDP Since 1890
Aggregate U.S.
output has increased
by a factor of 39
since 1890.
The logarithmic scale on the vertical axis allows

for the same proportional increase in a variable
to be represented by the same distance.
Growth in Rich
Output per capita equals GDP divided by

population.
The standard of living depends on the evolution
of output per capita, not total output.
To compare GDP across countries, we use a
common set of prices for all countries. Adjusted
real GDP numbers are measures of purchasing
power across countries, also called purchasing
power parity (PPP) numbers.

Growth in Rich
From the data in table 10-1 we conclude that:

▪ The standard of living has increased significantly since
1950.
▪ Growth rates of output per capita have decreased since
the mid-1970s.
▪ There has been convergence, that is, the levels of
output per capita across the five countries have become
closer over time. Real output per capita has increased
by a factor of 3.1 since 1950 in the United States, by a
factor of 4.1 in France, and by a factor of 10.2 in Japan.
▪ These numbers show what is sometimes called the
force of compounding.
The Construction of PPP Numbers

The construction of variables across countries using a
common set of prices underlies PPP estimates.

The Decrease in Growth Rates
Since the Mid-1970s
A very useful rule is the “rule of 70.” If a variable

grows at x% a year, then it will take
approximately 70 years for the variable to
double.
At a growth rate of 4.1% per year – the average
growth rate across the countries from Table 10-1
from 1950 to 1973 – it takes only 16 years for the
standard of living to double.
At a growth rate of 2.0% per year – the average
from 1973 to 2000 – it takes 35 years, more than
twice as long.

The Convergence of
Output per Capita
Figure 10 - 1
Growth Rate of GDP
per Capita Since
1950 Versus GDP
per Capita in 1950;
OECD Countries
Countries with lower

levels of output per
capita in 1950 have
typically grown faster.
The convergence of levels of output per capita

across countries is not specific to the four
countries we are looking at, it also extends to the
set of OECD countries.
A Broader Look Across
10-2
Time and Space
You should remember three basic facts about

growth in rich countries since 1950:
▪ The large increase in the standard of living
▪ The decrease in growth since the mid-1970s
▪ Convergence of output per capita
These are the three facts we shall keep in mind and
try to explain in the following chapters.

Chapter 10: The Facts of Growth Looking Across Two Millennia
There is agreement among economic historians

about the main economic evolutions over the last
2,000 years:
▪ From the end of the Roman Empire to roughly
year 1500, there was essentially no growth of
output per capita in Europe.
▪ From about 1500 to 1700, growth of output
per capita turned positive, about 0.1% per
year
▪ Even during the Industrial Revolution, growth
rates were not high by current standards.
▪ On the scale of human history, the growth of
output per capita is a recent phenomenon.

Chapter 10: The Facts of Growth Looking Across Two Millennia
Since 1870, the United States has been the

world’s economic leader. However, if history is
any guide, the United States may not remain the
lead forever. History looks more like
leapfrogging (in which countries get close to the
leader and then overtake it) than like
convergence (in which the race becomes closer
and closer).

Chapter 10: The Facts of Growth Looking Across Countries
Figure 10 - 3
Growth Rate of GDP
per Capita 1960-1990,
Versus GDP per
Capita in 1960 (1996
dollars); 99 countries
There is no clear
relation between the
growth rate of output
since 1960 and the
level of output per
capita in 1960.

Figure 10 - 4
Growth Rate of GDP
per Capita 1960-1990,
Versus GDP per
Capita in 1960:
OECD, Africa, and
Asia
Asian countries are
converging to OECD
levels. There is no
evidence of
convergence for
African countries.
The four triangles on the top left corner correspond to the four tigers:
Singapore, Taiwan, Hong Kong, and South Korea. All four have had average
annual growth rates of GDP per capita in excess of 5% over the last 30
years.
Let’s review the three basic facts discussed

earlier for the OECD:
▪ Growth is not a historical necessity.
▪ The convergence of output per capita in many
OECD countries toward the U.S. level may
well be the prelude to leapfrogging, a stage
when output per capita in one or more
countries increases above output per capita
in the United States.
▪ Finally, in a longer historical perspective, it is
not so much the lower growth since 1973 in
the OECD that is unusual.
Thinking About
10-3
Growth: A Primer
To think about the facts presented in the previous

sections, we use the framework of analysis
developed by Robert Solow, from MIT, in the
late 1950s. Particularly:
What determines growth?
What is the role of capital accumulation?
What is the role of technological progress?

Chapter 10: The Facts of Growth The Aggregate Production Function
The aggregate production function is a

specification of the relation between aggregate
output and the inputs in production.
Y = F ( K, N )
Y = aggregate output.
K = capital—the sum of all the machines, plants,
and office buildings in the economy.
N = labor—the number of workers in the
economy.
The function F, tells us how much output is
produced for given quantities of capital and labor.
Chapter 10: The Facts of Growth The Aggregate Production Function
The aggregate production function depends on

the state of technology. The higher the state of
technology, the higher
for a given K and a given N. Y = F ( K, N )
The state of technology is a set of blue prints

defining the range of products and the
techniques available to produce them.

Returns to Scale and
Returns to Factors
Constant returns to scale is a property of the

economy in which, if the scale of operation is
doubled—that is, if the quantities of capital and
labor are doubled—then output will also double.
2Y = F (2 K ,2 N )
Or more generally, for any number x,

xY = F ( xK , xN )

Returns to Scale and
Returns to Factors
Decreasing returns to capital refers to the

property that increases in capital lead to smaller
and smaller increases in output as the level of
capital increases.
Decreasing returns to labor refers to the
property that increases in labor, given capital,
lead to smaller and smaller increases in output
as the level of labor increases.

Output per Worker and
Capital per Worker
Constant returns to scale implies that we can

rewrite the aggregate production function as:
Y  K N K 
= F  ,  = F  ,1
N  N N N 
The amount of output per worker, Y/N depends

on the amount of capital per worker, K/N.
As capital per worker increases, so does output
per worker.

Output per Worker and
Capital per Worker
Figure 10 - 5
Output and Capital
per Worker
Increases in capital
per worker lead to
smaller and smaller
increases in output
per worker.
An increase in capital per worker, K/N, causes a

move along the production function.
Chapter 10: The Facts of Growth The Sources of Growth
Figure 10 - 6
The Effects of an
Improvement in the
State of Technology
An improvement in the
state of technology
shifts the production
function up, leading to
an increase in output
per worker for a given
level of capital per
worker.

Y  K N K 
= F  ,  = F  ,1
N  N N N 
Using the above equation, we can now
determine where growth comes from:
▪ Increases in output per worker (Y/N) can
come from increases in capital per worker
(K/N).
▪ Or they can come from improvements in the
state of technology that shift the production
function, F, and lead to more output per
worker given capital per worker.

Y  K N K 
= F  ,  = F  ,1
N  N N N 
Growth comes from capital accumulation and
from technological progress.
Because of decreasing returns to capital, capital
accumulation by itself cannot sustain growth.

We can think of growth as coming from capital

accumulation and from technological progress,
but these two factors play very different roles in
the growth process:
▪ Capital accumulation by itself cannot sustain
growth. Saving rate is the proportion of
income that is saved.
▪ Sustained growth requires sustained
technological progress. The rate of growth
of output per capita is eventually determined
by the economy’s rate of technological
progress.

Chapter 11:
Saving, Capital,
Accummulation and
Output

Saving, Capital Accumulation,
and Output
The effects of the saving rate - the ratio of

saving to GDP – on capital and output per capita
are the topics of this chapter.
An increase in the saving rate would lead to
higher growth for some time, and eventually to a
higher standard of living in the United States.

Interactions Between
11-1
Output and Capital
At the center of the determination of output in the

long run are two relations between output and
capital:
▪ The amount of capital determines the amount
of output being produced.
▪ The amount of output determines the amount
of saving and investment, and so the amount
of capital being accumulated.

Output and Capital
Figure 11 - 1
Capital, Output, and
Saving/Investment

Chapter 10: The Facts of Growth The Effects of Capital on Output
Under constant returns to scale, we can write the

relation between output and capital per worker as
follows:
Yt  Kt   Kt 
= f   = F 
N  N   N ,1
In words: Higher capital per worker leads to

higher output per worker.

Since the focus here is on the role of capital

accumulation, we make the following
assumptions:
▪ The size of the population, the participation
rate, and the unemployment rate are all
constant.
▪ There is no technological progress.

Under these assumptions, the first important

relation we want to express is between output
and capital per worker:
Yt  Kt 
= f 
N  N
In words, higher capital per worker leads to
higher output per worker.

The Effects of Output on
Capital Accumulation
We proceed in two steps:

First, we derive the relation between output
and investment.
Then, we derive the relation between
investment and capital accumulation.

Chapter 10: The Facts of Growth Output and Investment
We make three assumptions to derive the

relation between output and investment:
▪ We assume the economy is closed.
I = S + (T − G)
▪ We assume public saving, T – G, is equal to
zero.
I= S
▪ We assume that private saving is proportional
to income, so
S = sY
Combining these two relations gives: I t = sYt
Investment and
The evolution of the capital stock is given by:

Kt +1 = (1 −  ) Kt + I t
 denotes the rate of depreciation.
Combining the relation from output to investment,

I t = sYt , and the relation from investment to
capital accumulation, we obtain the second
important relation we want to express, from
output to capital accumulation:
Kt + 1 Kt Yt
= (1 −  ) +s
N N N
Investment and
Output and Capital per Worker:

Kt + 1 Kt Yt
= (1 −  ) +s
N N N
Rearranging terms in the equation above, we can
articulate the change in capital per worker over
time:
Kt +1 Kt Yt Kt
− = s −
N N N N
In words, the change in the capital stock per

worker (left side) is equal to saving per worker
minus depreciation (right side).

Implications of
11-2
Alternative Saving Rates
Our two main relations are:
Yt  Kt  Kt +1 Kt Yt Kt
= f  − = s −
N  N N N N N
▪First relation: ▪Second relation:
Capital determines Output determines
output. capital accumulation
Combining the two relations, we can study the

behavior of output and capital over time.

Chapter 10: The Facts of Growth Dynamics of Capital and Output
Yt  Kt  Kt +1 Kt Yt Kt
= f  − = s −
N  N N N N N
From our main relations above, we express

output per worker (Y/N) in terms of capital per
worker to derive the equation below:
Kt +1 Kt  Kt  Kt
− = sf   − 
N N  N N
change in capital from ▪ investment ▪ depreciation
year t to year t+1 during during year t
year t

− = sf   − 
N N  N N
change in capital from ▪ investment ▪ depreciation
year t to year t+1 during during year t
year t
If investment per worker exceeds depreciation
per worker, the change in capital per worker is
positive: Capital per worker increases.
If investment per worker is less than depreciation
per worker, the change in capital per worker is
negative: Capital per worker decreases.

Figure 11 - 2
Capital and Output
Dynamics
When capital and

output are low,
investment exceeds
depreciation, and
capital increases.
When capital and
output are high,
investment is less
than depreciation and
capital decreases.

At K0/N, capital
per worker is
low, investment
exceeds
depreciation,
thus, capital per
worker and
output per
worker tend to
increase over
time.

At K*/N, output
per worker and
capital per
worker remain
constant at their
long-run
equilibrium
levels.
▪ Investment per worker increases with capital per worker, but

by less and less as capital per worker increases.
▪ Depreciation per worker increases in proportion to capital
per worker.

Chapter 10: The Facts of Growth Steady-State Capital and Output
− = sf   − 
N N  N N
The state in which output per worker and capital
per worker are no longer changing is called the
steady state of the economy. In steady state,
the left side of the equation above equals zero,
then:  K *  K *
sf   =  
 N   N 
Given the steady state of capital per worker

(K*/N), the steady-state value of output per
worker (Y*/N), is given by the production
function:  Y *  K *
  = f 
 N  N 
Chapter 10: The Facts of Growth The Saving Rate and Output
Three observations about the effects of the

saving rate on the growth rate of output per
worker are:
1. The saving rate has no effect on the long run
growth rate of output per worker, which is
equal to zero.


worker are:
2. Nonetheless, the saving rate determines the
level of output per worker in the long run.
Other things equal, countries with a higher
saving rate will achieve higher output per
worker in the long run.


worker are:
3. An increase in the saving rate will lead to
higher growth of output per worker for some
time, but not forever. The saving rate does
not affect the long-run growth rate of output
per worker. After a higher saving rate, growth
will end once the economy reaches its new
steady state.

Figure 11 - 3
The Effects of
Different Saving
Rates
A country with a
higher saving rate
achieves a higher
steady-state level of
output per worker.

Figure 11 - 4
The Effects of an
Increase in the
Saving Rate on
Output per Worker
An increase in the
saving rate leads to a
period of higher
growth until output
reaches its new higher
steady-state level.

Chapter 10: The Facts of Growth The Saving Rate and Consumption
Figure 11 - 5
The Effects of an
Increase in the
Saving Rate on
Output per Worker in
an Economy with
Technological
Progress
An increase in the
saving rate leads to a
period of higher
growth until output
reaches a new, higher
path.

The level of capital

associated with the value of
the saving rate that yields the
highest level of consumption
in steady state is known as
the golden-rule level of
capital.

Figure 11 - 6
The Effects of the
Saving Rate on
Consumption per
Worker in Steady
State
An increase in the
saving rate leads to an
increase, then to a
decrease, in
consumption per
worker in steady state.

For s larger than sG,

increases in the
saving rate still lead
to higher capital and
output per worker, but
lower consumption
per worker.
For s=1, capital and
output per worker are
high, but all of the
output is used to
replace depreciation,
leaving nothing for
consumption.

Getting a Sense
11-3
of the Magnitudes
Assume the production function is:

Y= K N
Y K N K K
Output per worker is: = = =
N N N N
Output per worker, as it relates to capital per worker
is:  Kt  Kt
f  =
 N N
Given our second relation, − = sf   − 
N N  N N
Kt + 1 Kt Kt Kt
Then, − = s −
N N N N

The Effects of the Saving Rate on
Steady-State Output
Kt + 1 Kt Kt Kt
− = s −
N N N N
K K
In steady state, the left side equals zero, then:s =
N N
2
K  K
Squaring both sides, s2 =  
N  N
2
K  s
Dividing by (K/N) and rearranging, = 
N  
In words, the steady state capital per worker is
equal to the square of the ratio of the saving rate
to the depreciation rate.
2
Y K  s s
Output per worker is given by: = =   =
N N   

The Effects of the Saving Rate on
Steady-State Output
2
Y K  s s
= =   =
N N   
Steady-state output per worker is equal to the
ratio of the saving rate to the depreciation rate.
A higher saving rate and a lower depreciation
rate both lead to higher steady-state capital per
worker and higher steady-state output per
worker.

The Dynamic Effects of an
Increase in the Saving Rate
Figure 11 - 7
Dynamic Effects of
an Increase in the
Saving Rate from 10
to 20% on the Level
and the Growth Rate
of Output per Worker
It takes a long time for
output to adjust to its
new higher level after
an increase in the
saving rate. Put
another way, an
increase in the saving
rate leads to a long
period of higher
growth.
The U.S. Saving Rate
and the Golden Rule
In steady state, consumption per worker is equal

to output per worker minus depreciation per
worker. C Y K
= −
N N N
2
K  s Y K  s
2
s
Knowing that: =  and = =   =
N   N N   
s(1 − s)
2
then: C s  s
= −   =
N    
These equations are used to derive the Table 11-1

in the next slide.

The U.S. Saving Rate
and the Golden Rule
The Saving Rate and the Steady-state Levels of Capital,

Table 11-1
Output, and Consumption per Worker (=10%)
Capital per worker, Output per Consumption per
Saving Rate, s K/N worker, Y/N worker, C/N
2
K  s
= 
Y
=
s C s(1 − s)
N   N  =
N 
0.0 0.0 0.0 0.0
0.1 1.0 1.0 0.9
0.2 4.0 2.0 1.6
0.3 9.0 3.0 2.1
0.4 16.0 4.0 2.4
0.5 25.0 5.0 2.5
0.6 36.0 6.0 2.4
– – – –
1.0 100.0 10.0 0.0

Physical Versus
11-4
Human Capital
The set of skills of the workers in the economy is

called human capital.
An economy with many highly skilled workers is
likely to be much more productive than an
economy in which most workers cannot read or
write.
The conclusions drawn about physical capital
accumulation remain valid after the introduction
of human capital in the analysis.

Chapter 10: The Facts of Growth Extending the Production Function
When the level of output per workers depends on

both the level of physical capital per worker, K/N,
and the level of human capital per worker, H/N,
the production function may be written as:
Y  K H
= f , 
N  N N
(+ , + )
An increase in capital per worker or the average

skill of workers leads to an increase in output per
worker.

Chapter 10: The Facts of Growth Extending the Production Function
A measure of human may be constructed as

follows:
Suppose an economy has 100 workers, half of
them unskilled and half of them skilled.
The relative wage of skilled workers is twice that
of unskilled workers. Then:
H 150
H = [(50  1) + (50  2)] = 150  = = 15
.
N 100

Human Capital, Physical
Capital, and Output
An increase in how much society “saves” in the

form of human capital—through education and
on-the-job-training—increases steady-state
human capital per worker, which leads to an
increase in output per worker.
In the long run, output per worker depends not
only on how much society saves but also how
much it spends on education.

Human Capital, Physical
Capital, and Output
In the United States, spending on education comprises

about 6.5% of GDP, compared to 16% investment in
physical capital. This comparison:
▪ Accounts for the fact that education is partly
consumption.
▪ Does not account for the opportunity cost of
education.
▪ Does not account for the opportunity cost of on-the-
job-training.
▪ Considers gross, not net investment. Depreciation
of human capital is slower than that of physical
capital.
Chapter 10: The Facts of Growth Endogenous Growth
A recent study has concluded that output per

worker depends roughly equally on the amount
of physical capital and the amount of human
capital in the economy.
Models that generate steady growth even without
technological progress are called models of
endogenous growth, where growth depends on
variables such as the saving rate and the rate of
spending on education.

Chapter 12:
Technological Progress and
Growth

Technological Progress
12-1
and the Rate of Growth
Technological progress has many dimensions. It

may mean:
▪ Larger quantities of output
▪ Better products
▪ New products
▪ A larger variety of products
Technological progress leads to increases in
output for given amounts of capital and labor.

and the Production Function
Let’s denote the state of technology by A and

rewrite the production function as:
Y = F ( K , N , A)
(+ + +)
A more restrictive but more convenient form is

Y = F ( K , AN )
Output depends on both capital and labor (K and
N), and on the state of technology (A).

▪ Technological progress reduces the number of

workers needed to achieve a given amount of
output.
▪ Technological progress increases AN, which
we can think of as the amount of effective
labor, or labor in “efficiency units.” in the
economy.
With constant returns to scale,
2Y = F (2 K ,2 AN )
More generally,
xY = F ( xK , xAN )

The relation between output per effective worker

and capital per effective worker is:
Y  K 
= F ,1
AN  AN 
which we can redefine as
Y  K 
= f 
AN  AN 
In words: Output per effective worker is a
function of capital per effective worker.

Figure 12 - 1
Output per Effective
Worker Versus
Capital per Effective
Worker
Because of
decreasing returns to
capital, increases in
capital per effective
worker lead to
smaller and smaller
increases in output
per effective worker.

Output and Capital
The dynamics of output and capital per worker

involve:
▪ The relation between output per worker and
capital per worker.
I = S = sY
Dividing both sides by AN, we get
I  Y 
= s 
AN  AN 

Output and Capital

involve:
▪ The relation between investment per worker
and capital per worker.
Y  K  I  K 
Given that = f  then = sf  
AN  AN  AN  AN 

Output and Capital

involve:
▪ The relation between depreciation per
worker—equivalently, the investment per
worker needed to maintain a constant level of
capital per worker—and capital per worker.
K + ( g A = g N ) K
or equivalently ( + g A + g N ) K
The amount of investment per effective worker needed to
maintain a constant level of capital per effective worker is
K
( + g A + g N )
AN
Output and Capital
Figure 12 - 2
Dynamics of Capital
per Worker and
Output per Effective
Worker
Capital per effective

worker and output per
effective worker
converge to constant
values in the long
run.

This figure focuses on

output, capital, and
investment per effective
worker, rather than per
worker:
▪ Output per effective
worker increases with
capital per effective
worker, but at a
decreasing rate.


worker:
▪ The relation between
worker and capital per
effective worker is drawn
as the upper curve,
multiplied by the saving
rate, s.


worker:
▪ Finally, now that we
allow for technological
progress (so A increases
over time), the number of
effective workers (AN)
increases over time.

We can now give a graphical description of the dynamics

of capital per effective worker and output per effective
worker:
▪ Because actual investment exceeds the investment
level required to maintain the existing level of capital
per effective worker, K/AN increases.
▪ Starting from (K/AN)0, the economy moves to the right,
with the level of capital per effective worker increasing
over time.
▪ In the long run, capital per effective worker reaches a
constant level, and so does output per effective
worker.
▪ This implies that output (Y) is growing at the same rate
as effective labor (AN).
In steady state, output (Y) grows at the same rate as

effective labor (AN); effective labor grows at a rate
(gA+gN); therefore, output growth in steady state
equals (gA+gN). Capital per effective worker also
grows at a rate equal to (gA+gN).
The growth rate of output is independent of the
saving rate.
Because output, capital, and effective labor all grow
at the same rate, (gA+gN), the steady state of the
economy is also called a state of balanced growth.

Table 12-1 The Characteristics of Balanced Growth

Rate of growth of:
1 Capital per effective worker 0
2 Output per effective worker 0
3 Capital per worker gA
4 Output per worker gA
5 Labor gN
6 Capital gA + gN
7 Output gA + gN

On the balanced growth path (equivalently, in

steady state; equivalently, in the long run):
Capital per effective worker and output per
effective worker are constant.
Equivalently, capital per worker and output per
worker are growing at the rate of
technological progress, gA.
Or, in terms of labor, capital, and output: Labor
is growing at the rate of population growth,
gN; capital and output are growing at a rate
equal to the sum of population growth and the
rate of technological progress, (gA + gN).

Chapter 10: The Facts of Growth The Effects of the Saving Rate
Figure 12 - 3
The Effects of an
Increase in the
Saving Rate: I
An increase in the
saving rate leads to
an increase in the
steady-state levels of
output per effective
worker and capital
per effective worker.

Chapter 10: The Facts of Growth The Effects of the Saving Rate
Figure 12 - 4
The Effects of an
Increase in the
Saving Rate: II
The increase in the

saving rate leads to
higher output growth
until the economy
reaches its new,
higher, balanced
growth path.

The Determinants of
12-2
Technological progress in modern economies is

the result of firms’ research and development
(R&D) activities. The outcome of R&D is
fundamentally ideas.
Spending on R&D depends on:
The fertility of the research process, or how
spending on R&D translates into new ideas and
new products, and
The appropriability of research results, or the
extent to which firms benefit from the results of
their own R&D.

Chapter 10: The Facts of Growth The Fertility of the Research Process
The determinants of fertility include:

▪ The interaction between basic research (the
search for general principles and results) and
applied research (the application of results to
specific uses).
▪ The country: some countries are more
successful at basic research; others are more
successful at applied research and
development.
▪ Time: It takes many years, and often many
decades, for the full potential of major
discoveries to be realized.
The Appropriability
of Research Results
If firms cannot appropriate the profits from the

development of new products, they will not
engage in R&D. Factors at work include:
▪ The nature of the research process. Is there
a payoff in being first at developing a new
product?
▪ Legal protection. Patents give a firm that has
discovered a new product the right to exclude
anyone else from the production or use of the
new product for a period of time.

The Facts of
12-3
Growth Revisited
Recall from Chapter 10 that we looked at growth

in rich countries since 1950, and we identified
three main facts:
▪ Sustained growth, especially from 1950 to the
mid-1970’s
▪ A slowdown in growth starting in the mid-
1970’s
▪ Convergence: Countries that were further
behind have been growing faster
Keep this in mind as we look ahead.

Capital Accumulation Versus
Fast growth may come from two sources:

▪ A higher rate of technological progress. If gA
is higher, balanced output growth (gY=gA+gN)
will also be higher. In this case, the rate of
output growth equals the rate of technological
progress.
▪ Adjustment of capital per effective worker,
K/AN, to a higher level. In this case, the
growth rate of output exceeds the rate of
technological progress.

Table 12-2 Average Annual Rates of Growth of Output per Capita

and of Technological Progress in Five Rich
Countries, 1950-2000
Rate of Growth of Output per Rate of Technological Progress
Worker (%) (%)
1950-1973 1973-2000 Change 1950-1973 1973-2000 Change
(1) (2) (3) (4) (5) (6)
France 4.8 2.1 -2.7 5.3 1.6 -3.7
Japan 7.1 2.1 -5.0 7.0 1.4 -5.6
United Kingdom 3.4 1.7 -1.7 3.7 1.9 -1.8
United States 2.7 1.2 -1.5 2.9 1.4 -1.5
Average 4.5 1.8 -2.7 4.7 1.6 -3.1

Table 12-2 illustrates three main facts:

1. The period of high growth of output per
capita, from 1950 to 1973, was due to rapid
technological progress, not to unusually high
capital accumulation.
2. The slowdown in growth of output per capita
since 1973 has come from a decrease in the
rate of technological growth, not from
unusually low capital accumulation.
3. Convergence of output per capita across
countries has come from higher technological
progress rather than from faster capital
accumulation.

Fluctuation in the Pace of
Why did technological progress slow down in the

mid-1970s? The truth is that, despite a large
amount of research, this slowdown remains
largely a mystery.
One hypothesis is that there was a general
decline in R&D, which led to lower technological
progress.
Another hypothesis is that the decline was not in
the amount but in the fertility of R&D.

Chapter 10: The Facts of Growth 12-4 Institutions and Growth
Figure 12 - 5
Protection from
Expropriation and
GDP per Capita
There is a strong
positive relation
between the degree
of protection from
expropriation and the
level of GDP per
capita.

The Importance of
Institutions: North and South
Korea
Figure 1
PPP GDP per
Capita, North and
South Korea,
1950-1998

Technological
Progress, Wages,
and Unemployment
CHAPTER 13
CHAPTER13
Prepared by:
Fernando Quijano and Yvonn Quijano
© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard

Technological Progress, Wages,
and Unemployment
Chapter 13: Technological Progress,
There are optimistic and pessimistic views of

technological progress.
Wages, and Unemployment
Technological unemployment—a concept

associated with the technocracy movement
during the Great Depression—is the argument
that unemployment comes from the introduction
of machinery.

Productivity, Output, and
13-1
Unemployment in the Short Run
A production function with technological progress

can be written as:
Y = F ( K , AN )
Leaving aside matters concerning capital, then:
Y = AN
Output is produced using only labor, N, and each
worker produces A units of output. Increases in
A represent technological progress.

Productivity, Output, and
Unemployment in the Short Run
Y = F ( K , AN )
Then, employment is equal to output divided by

productivity.
Y
N=
A
The concern is that, given output, an increase in

productivity decreases the level of employment.
This chapter explores this issue, in particular, the
short- and medium-run responses of output,
employment, and unemployment.

Technological Progress, Aggregate
Supply, and Aggregate Demand
Figure 13 - 1
Aggregate Supply and
Aggregate Demand for

a Given Level of
Productivity
The aggregate supply

curve is upward sloping.
An increase in output
leads to an increase in
the price level. The
aggregate demand
curve is downward
sloping. An increase in
the price level leads to a
decrease in output.

The impact of an increase in productivity on

output and employment in the short run depends
on how it affects the aggregate supply and

aggregate demand curves.
Higher productivity decreases the amount of
labor needed to produce a unit of output,
resulting in lower cost and a lower price for a
given output level. The aggregate supply curve
shifts down.

The effects of higher productivity on aggregate

demand depend on the source of the productivity
increase:
▪ Technological breakthroughs will bring
prospects of higher profits and a boom in
investment. The demand for goods rises—
aggregate demand shifts to the right.
▪ The more efficient use of existing
technologies may require little or no new
investment. Worries about job security will
trigger more saving—the aggregate demand
curve shifts to the left.

Figure 13 - 2
The Effects of an
Increase in
Productivity on Output
in the Short Run
An increase in
productivity shifts the
aggregate supply curve
down. It has an
ambiguous effect on the
aggregate demand
curve, which may shift
to the left or to the right.
In this figure, we
assume a shift to the
right.
The Empirical Evidence
Figure 13 - 3
U.S. Labor
Productivity and
Output Growth
since 1960
There is a strong
positive relation
between output
growth and
productivity growth.
But the causality
runs from output
growth to
productivity growth,
not the other way
around.
Research on the effects of exogenous

movements in productivity growth on output
shows that:
▪ Sometimes increases in productivity lead to
increases in output sufficient to maintain or
even increase employment in the short run.
▪ Sometimes they do not, and unemployment
increases in the short run.
Productivity and the
Natural Rate of Unemployment
Consider price setting first:

▪ From Y = AN , each worker produces A unit
of output.
▪ If the nominal wage is equal to W, the
nominal cost of producing one unit of output
is therefore equal to (1/A) W = W/A
▪ If firms set their price equal to 1+ times cost,
the price level is given by:
W
Price setting P = (1 + )
A
Productivity and the
Natural Rate of Unemployment
An extension of our earlier wage-setting equation

that accounts for increases in productivity equals:
Wage setting W = A e P e F (u, z)

Wages now depend on the expected level of
productivity.
▪ Workers care about real wages, not nominal

wages, so wages depend on the (expected)
price level, Pe.
▪ Wages now also depend on the expected
level of productivity, Ae.
The Natural Rate of Unemployment
The real wage paid by firms, W/P, increases one

for one with productivity, A. Higher productivity
leads to a lower price set by firms given the

nominal wage; therefore, the real wage rate
rises.
W A
=
P 1+ 
Under the condition that expectations are correct,

then Pe=P and Ae=A, the wage-setting equation

becomes:
W
= AF (u, z)
P
The real wage rate depends on both the level of
productivity and the unemployment rate.
Figure 13 - 4
The Effects of an
Increase in
Productivity on the
Natural Rate of
Unemployment
An increase in
productivity shifts both
the wage- and the price-
setting curves by the
same proportion, and
thus has no effect on
the natural rate of
unemployment.
W A
▪ From =
P 1+  , we see that the real wage
implied by price setting is now higher by 3%.
W
▪ From P = AF (u, z) , we see that at a given
unemployment rate, the real wage implied by
wage setting is also higher than 3%.
▪ Note that at the initial unemployment rate un,
both curves shift up by the same amount,
namely, 3% of the initial real wage.
Figure 13 - 5
Productivity Growth
and Unemployment—
Averages by Decade
since 1890
There is little relation
between the 10-year
averages of productivity
growth and the 10-year
averages of the
unemployment rate. If
anything, higher
productivity growth is
associated with lower
unemployment.
Figure 13 - 6
The Effects of a
Decrease in
Productivity Growth on
the Unemployment Rate
When Expectations of
Productivity Growth
Adjust Slowly
If it takes time for
workers to adjust their
expectations of
productivity growth, a
slowdown in productivity
growth will lead to an
increase in the natural
rate of unemployment
for some time.
Let’s summarize what we have seen in this and the

preceding section:
▪ In the short run, there is no reason to expect a

systematic relation between movements in
productivity growth and movements in
unemployment.
▪ In the medium run, if there is a relation between
productivity growth and unemployment, it
appears to be an inverse relation.
Given this evidence, structural change – the
change in the structure of the economy induced
by technological progress, may where fears of
technological unemployment come from.
13-3
and Distribution Effects
Joseph Schumpeter, a Harvard economists,

emphasized that the process of growth was
fundamentally a process of creative

destruction– new goods are developed, making
old ones obsolete, new techniques of production
are introduced.
Churning is the term used to describe how new
techniques of production require new skills and
make old skills less useful.
The Increase in Wage Inequality
Technological change is the reason for the large

increase in wage inequality in the United States
during the last 25 years.

At the low end of the education ladder, both the
relative and the absolute wage of workers has
declined.
At the high end, the relative wage of those with
an advanced degree has increased by 25% since
the early 1980s.
The Increase in Wage Inequality
Figure 13 - 7
Evolution of Relative
Wages, by Education
Level. (1973 = 1.0)
Since the early 1980s,

the relative wage of
workers with a low
education level has
decreased; the
relative wage of
workers with a high
education level has
increased.
The Causes of Increased
Wage Inequality
Among the arguments for the steady increase in

the relative wage rate of skilled workers are:
▪ International trade: Firms that hire low-skilled

workers usually go abroad to find this source
of labor.
▪ Skill-biased technological progress: New
machines and productive methods require
high-skill workers with better education.
Wage Inequality
There are at least three reasons to think that the

future may be different from the recent past
where wage inequality is concerned:

▪ The trend in relative demand may simply slow
down.
▪ Technological progress is not exogenous
▪ The relative supply of high-skill versus low-
skill workers is also not exogenous.
Chapter 10: The Facts of Growth The Natural Rate of Unemployment
Figure 13 - 4
The Effects of an
Increase in
Productivity on the
Natural Rate of
Unemployment
An increase in
productivity shifts both
the wage- and the price-
setting curves by the
same proportion, and
thus has no effect on
the natural rate of
unemployment.
Chapter 10: The Facts of Growth The Natural Rate of Unemployment
W A
▪ From =
P 1+  , we see that the real wage
implied by price setting is now higher by 3%.
W
▪ From P = AF (u, z) , we see that at a given
unemployment rate, the real wage implied by
wage setting is also higher than 3%.
▪ Note that at the initial unemployment rate un,
both curves shift up by the same amount,
namely, 3% of the initial real wage.
Chapter 10: The Facts of Growth The Empirical Evidence
Figure 13 - 5
Productivity Growth
and Unemployment—
Averages by Decade
since 1890
There is little relation
between the 10-year
averages of productivity
growth and the 10-year
averages of the
unemployment rate. If
anything, higher
productivity growth is
associated with lower
unemployment.
Figure 13 - 6
The Effects of a
Decrease in
Productivity Growth on
the Unemployment Rate
When Expectations of
Productivity Growth
Adjust Slowly
If it takes time for
workers to adjust their
expectations of
productivity growth, a
slowdown in productivity
growth will lead to an
increase in the natural
rate of unemployment
for some time.
Let’s summarize what we have seen in this and the

preceding section:
▪ In the short run, there is no reason to expect a
systematic relation between movements in
productivity growth and movements in
unemployment.
▪ In the medium run, if there is a relation between
productivity growth and unemployment, it
appears to be an inverse relation.
Given this evidence, structural change – the
change in the structure of the economy induced
by technological progress, may where fears of
technological unemployment come from.
13-3
and Distribution Effects
Joseph Schumpeter, a Harvard economists,

emphasized that the process of growth was
fundamentally a process of creative
destruction– new goods are developed, making
old ones obsolete, new techniques of production
are introduced.
Churning is the term used to describe how new
techniques of production require new skills and
make old skills less useful.
Chapter 10: The Facts of Growth The Increase in Wage Inequality
Technological change is the reason for the large

increase in wage inequality in the United States
during the last 25 years.
At the low end of the education ladder, both the
relative and the absolute wage of workers has
declined.
At the high end, the relative wage of those with
an advanced degree has increased by 25% since
the early 1980s.
Chapter 10: The Facts of Growth The Increase in Wage Inequality
Figure 13 - 7
Evolution of Relative
Wages, by Education
Level. (1973 = 1.0)
Since the early 1980s,

the relative wage of
workers with a low
education level has
decreased; the
relative wage of
workers with a high
education level has
increased.
Wage Inequality
Among the arguments for the steady increase in

the relative wage rate of skilled workers are:
▪ International trade: Firms that hire low-skilled
workers usually go abroad to find this source
of labor.
▪ Skill-biased technological progress: New
machines and productive methods require
high-skill workers with better education.
Wage Inequality
There are at least three reasons to think that the

future may be different from the recent past
where wage inequality is concerned:
▪ The trend in relative demand may simply slow
down.
▪ Technological progress is not exogenous
▪ The relative supply of high-skill versus low-
skill workers is also not exogenous.

Economic Growth

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Economic Growth

Uploaded by

Copyright:

Available Formats

The Facts

© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard

We now turn from the determination of output in

© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard 2 of 30

The logarithmic scale on the vertical axis allows

Output per capita equals GDP divided by

© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard 4 of 30

From the data in table 10-1 we conclude that:

The Construction of PPP Numbers

© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard 5 of 30

A very useful rule is the “rule of 70.” If a variable

© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard 6 of 30

Countries with lower

The convergence of levels of output per capita

You should remember three basic facts about

© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard 8 of 30

There is agreement among economic historians

© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard 9 of 30

Since 1870, the United States has been the

© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard 10 of 30

© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard 11 of 30

Let’s review the three basic facts discussed

To think about the facts presented in the previous

© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard 14 of 30

The aggregate production function is a

The aggregate production function depends on

The state of technology is a set of blue prints

© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard 16 of 30

Constant returns to scale is a property of the

Or more generally, for any number x,

© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard 17 of 30

Decreasing returns to capital refers to the

© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard 18 of 30

Constant returns to scale implies that we can

The amount of output per worker, Y/N depends

© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard 19 of 30

An increase in capital per worker, K/N, causes a

© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard 21 of 30

© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard 22 of 30

© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard 23 of 30

We can think of growth as coming from capital

© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard 24 of 30

© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard 25 of 30

The effects of the saving rate - the ratio of

© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard 26 of 42

At the center of the determination of output in the

© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard 27 of 42

© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard 28 of 42

Under constant returns to scale, we can write the

In words: Higher capital per worker leads to

© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard 29 of 42

Since the focus here is on the role of capital

© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard 30 of 42

Under these assumptions, the first important

© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard 31 of 42

We proceed in two steps:

© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard 32 of 42

We make three assumptions to derive the

The evolution of the capital stock is given by:

Combining the relation from output to investment,

Output and Capital per Worker:

In words, the change in the capital stock per

© 2006 Prentice Hall Business Publishing Macroeconomics, 4/e Olivier Blanchard 35 of 42