Chapter 7

Production and Growth

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In this chapter, you will

 See how economic growth differs around the world

 Learn why productivity matters for living standards
 Analyze the factors that determine productivity and
economic growth
 Examine how public policy affects economic growth

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Incomes and Growth Around the
World

FACT 1: There are vast differences

in living standards around the world.

FACT 2: There is also great

variation in growth rates across
countries.

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 Production and growth

 The average person in a rich country, such

as Canada, the United States, or Germany,
has an income more than ten times as high
as the average person in a poor country.
 Production and growth

 In Canada over the past century, average

income as measured by real GDP per
person has grown by about
2 percent per year.
 Average income today is about eight
times as high as average income a century
ago.
 Production and growth

 Growth rates vary substantially from

country to country.
 From 2000 to 2014:
 GDP per person in China grew at a rate of 11
percent per year, accumulating to a 357 percent
increase in average income.
 Income per person in Zimbabwe fell by a total of
13 percent.

Copyrig
ht ©
TABLE 7.1
The Variety of Growth Experiences
 Incomes and Growth Around the World
Since growth rates vary, the country rankings can
change over time:
 Poor countries are not necessarily doomed to
poverty forever – e.g., Singapore, incomes were
low in 1960 and are quite high now.
 Rich countries can’t take their status for granted:
They may be overtaken by poorer but
faster-growing countries (Argentina).

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Incomes and Growth Around the World
Questions:
 Why are some countries richer than
others?
 Why do some countries grow quickly while
others seem stuck in a poverty trap?
 What policies may help raise growth rates
and long-run living standards?

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 Determinants of labor productivity
 Let’s build the “temple” of productivity
 Productivity = output per worker and output per
unit of capital
The “4 pillars of productivity”
 The “4 Pillars of Productivity”
1. Human Capital: productive knowledge and skills
that workers acquire through education, training,
and experience
2. Physical Capital: stock of tools, machines,
structures, equipment
3. Natural Resources: gifts of nature such as
timber, oil, water, etc
4. Technological Knowledge: knowledge that
makes technology possible

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 Saving and Investment
 Investment is required for strengthening the 4
pillars of productivity

 Saving required for investment (we will learn this

in the next chapter)

 The opportunity cost of saving: foregone

consumption today
The Role of Saving and Investment
Ultimate productivity determinants
Ultimate Productivity Determinants
1. Political Stability: stable, honest
government, no civil wars, no corruption,
dependable legal system, good institutions
2. Respect for Private Property: no fear of
government expropriation
3. Modest Taxation
4. Free Trade and Competitive Markets
5. Investment in Infrastructure
6. Good Health Care and Education
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 A Note on Property Rights and Political
Stability

• In many poor countries, the justice system

doesn’t work very well:
• Contracts aren’t always enforced
• Fraud, corruption often go unpunished
• In some, firms must bribe govt officials for
permits
• Political instability (e.g., frequent coups) creates
uncertainty over whether property rights will be
protected in the future.

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 Property Rights and Political Stability

 When people fear their capital may be stolen by

criminals or confiscated by a corrupt govt,
there is less investment, including from abroad,
and the economy functions less efficiently.
Result: lower living standards.
 Economic stability, efficiency, and healthy growth
require law enforcement, effective courts,
a stable constitution, and honest govt officials.

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 Free Trade
 Recall: Trade can make everyone better off.
 Trade has similar effects as discovering new
technologies – it improves productivity and living
standards.
 Countries with inward-oriented policies have
generally failed to create growth.
• E.g., Argentina during the 20th century.
 Countries with outward-oriented policies have
often succeeded.
• E.g., South Korea, Singapore, Taiwan after 1960.
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 Population Growth
…may affect living standards in 3 different ways:
1. Stretching natural resources
 200 years ago, Malthus argued that pop. growth
would strain society’s ability to provide for itself.
 Since then, the world population has increased
sixfold. If Malthus was right, living standards would
have fallen. Instead, they’ve risen.
 Malthus failed to account for technological
progress and productivity growth.

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 Population Growth
2. Diluting the capital stock
 Bigger population = labour force grows more
rapidly than the capital stock = less physical
capital per worker = lower productivity & living
standards.
 This also applies to human capital:
fast population growth = more children
= greater strain on educational system.
 Countries with fast population growth tend to have
lower educational attainment.

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 Population Growth
3. Promoting technological progress
More people implies
• more scientists, inventors, engineers
• more frequent discoveries
• faster tech. progress & economic growth

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 Population Growth
Population clock:
https://www.worldometers.info/world-population/#:
~:text=The%20current%20world%20population%
20is%207.8%20billion%20as,currently%20living%
29%20of%20the%20world.%207%20Billion%20%
282011%29
 Currently there are about 7.8 billion people on
this planet.
 The United Nations projects world population to
reach 10 billion in the year 2057.

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ECONOMIC GROWTH AND PUBLIC
POLICY
DIMINISHING RETURNS AND THE CATCH-UP EFFECT
 As the capital stock increases, productivity increases
thus leading to a higher rate of growth of GDP.
 Diminishing returns refers to the benefits from
additional capital becoming smaller over time, so
growth slows down.
 Diminishing returns: the benefit from an extra unit of
an input declines as the quantity of the input
increases.
FIGURE 7.1
Illustrating the
Production Function
ECONOMIC GROWTH AND PUBLIC
POLICY
DIMINISHING RETURNS AND THE CATCH-UP
EFFECT (CONT’D)
 The diminishing returns to capital has
another important implication: it is easier for
a country to grow if it starts out relatively
poor.
 Catch-up effect: countries that start off poor
tend to grow more rapidly than countries
that start off rich.
ACTIVE LEARNING 2
Review productivity concepts
 List the determinants of productivity.
 List three policies that attempt to raise living
standards by increasing one of the determinants
of productivity.

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ACTIVE LEARNING 2
Answers
Determinants of productivity:
physical capital per worker
human capital per worker
natural resources per worker
technological knowledge
Policies to boost productivity:
 Encourage saving and investment
 Encourage investment from abroad
 Provide public education
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