Macro Ch03

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Economic Growth

Transcript of Macro Ch03

  • 27

    n 2000, the real GDP per person in the United States was $34,800 (valued in U.S. dollars for the year 2000). This high output

    per person meant that the typical U.S. resident had a high standard of living, which refers to the quantity and quality of the

    goods and services consumed. Most families had their own home, at least one car, several television sets, education at least

    through high school and often college, and a level of health that translated into a life expectancy at birth of nearly 80 years.

    Nearly as high standards of living applied to most Western European countriesincluding the United Kingdom, Germany,

    France, and Italyand a few other places, such as Canada, Australia, New Zealand, Japan, Singapore, and Hong Kong.

    The residents of most other countries were not nearly as well o in 2000. For example, the real GDP per person was $9,100

    in Mexico, $3,900 in China, $2,600 in India, and $740 in Nigeria, the most populous country in Africa.1 Lower real GDPs per person

    meant lower standards of living. The typical resident of Mexico could a ord food, shelter, and basic health care but could not attain

    the range and quality of consumer goods available to most Americans. Even more seriously, the typical Nigerian had concerns

    about nutrition and housing, and faced a life expectancy at birth of less than 50 years.

    How can countries with low real GDP per person catch up to the high levels enjoyed by the United States and other rich

    countries? The only answer is to have a high rate of economic growththe rate at which real GDP per person increasesover

    long periods, such as 20 or 40 years. To illustrate, Table 3.1 shows the level of real GDP per person that China would attain in

    2020, based on its growth rate of real GDP per person from 2000 to 2020. It would take a growth rate of 10% per yearan unprec-

    edented accomplishment for 20 yearsfor Chinas real GDP per person in 2020 to approach $30,000, nearly the U.S. level in 2000.

    Moreover, since the U.S. real GDP per person will likely be growing, even a 10% growth rate would leave Chinas real GDP per person

    in 2020 far short of the U.S. level. Worse yet, if Chinas real GDP per person grew at only 2% per year, its level of real GDP per person in

    2020 would be only $5,800, 17% of the U.S. level in 2000. Thus, di erences in rates of economic growth, when sustained for 20 years

    or more, make an enormous di erence in standards of living, measured by levels of real GDP per person.

    The bene ts of sustained economic growth apply to all nations, not just China. Thus, the universal question is, what can

    weor our governmentsdo to increase the rate of economic growth? The importance of this question inspired economist

    Robert Lucas (1988) to ask: Is there some action a government of India could take that would lead the Indian economy to grow like

    Indonesias or Egypts? If so, what, exactly? If not, what is it about the nature of India that makes it so? The consequences for human

    welfare involved in questions like these are simply staggering: once one starts to think about them, it is hard to think about

    Introduction to Economic Growth

    CHAPTER 3

    1 These GDP numbers adjust for purchasing-power di erences across countries. The data are from Alan Heston, Robert Summers, and Bettina Aten (2002).

    I

    C h a p t e r 3 : I n t r o d u c t i o n t o E c o n o m i c G r o w t h

    Image Copyright Denise Kappa, 2009. Used under license from Shutterstock.com

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    Table 3.1 Economic Growth and Chinas Real GDP per Person in 2020*

    Growth Rate of Real GDP per Person from 2000 to 2020

    Real GDP per Person in 2020 (in 2000 dollars)

    2% per year 5,820

    5% per year 10,600

    10% per year 28,800

    *China starts with real per capita GDP of $3,900 in 2000. We calculate the level of real GDP per person in 2020 as follows. Start with

    the natural logarithm of real GDP per person in 2000: ln (3,900) = 8.269. Then multiply the number of years, 20, by the growth rate

    for example, 0.02 if the growth rate is 2% per year: 20 0.02 = 0.40. Add this to 8.269 to get 8.669. Then take the exponential of

    8.669 to get the answer, 5,820.

    2 When Lucas wrote these words in the mid-1980s, India had been growing more slowly than Egypt and Indonesia for some time. The growth rates of real GDP per person from 1960 to 1980 were 2.5% per year in Egypt, 3.5% in Indonesia, and 1.6% in India. However, India did manage to surpass the other two countries in terms of growth rates from 1980 to 2000: The growth rates of real GDP per person were 2.7% per year for Egypt, 3.3% for Indonesia, and 3.8% for India. Thus, the Indian government may have met Lucass challenge.

    anything else (p. 5).2 Questions like these underline the challenge of developing policies that promote economic growth. This challenge motivates the study that we be-gin in this chapter and continue in the following two chapters.

    We start by presenting key facts about economic growth, fi rst for a large number of countries since 1960 and, second, for the United States and other rich countries for over a century. These observations bring out patterns that we need to understand to design policies to promote economic growth. As a way to gain this understanding, we construct a model of eco-nomic growth, called the Solow model. In Chapters 4 and 5, we extend this model and see how these exten-sions relate to patterns of economic growth and to Lucass policy challenge.

    Facts About Economic GrowthEconomic Growth Around the World from 1960 to 2000We start our study of economic growth by comparing living standardsgauged by real GDP per personfor a large number of countries. This comparison will allow

    us to see at a glance which countries are rich and which are poor. In Figure 3.1, the horizontal axis plots real GDP per person (in U.S. dollars for the year 2000), and the vertical axis shows the number of countries with each real GDP per person in 2000. The graph applies to 151 countries with data, and representative countries are labeled for each bar.

    The United States, with a real GDP per person of $34,800, was only the second richest country in 2000the number one spot went to Luxembourg, a very small country, with $45,900. More generally, the top positions were dominated by the long-term members of the rich countries club, which is known as the Organization for Economic Cooperation and Development (OECD). This elite group includes most of Western Europe, the United States, Canada, Australia, New Zealand, and Japan. Overall, 20 of the richest 25 economies in 2000 were OECD members. The other fi ve were Singapore (ranked 3rd), Hong Kong (6th), Macao (14th), Cyprus (23rd), and Taiwan (25th). (Hong Kong and Macao are parts of China, and Taiwans status is in dispute.)

    The poorest country in Figure 3.1 is Congo (Kinshasa), a sub- Saharan African country, with a real GDP per person of $238, again in 2000 U.S. dollars. Therefore, in 2000, the richest country (Luxembourg) had a real GDP per person that was 193 times that of the poorest country. If we exclude Luxembourg because of its small size and compare instead with the United States, we fi nd that the United States had a real GDP per person

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  • C h a p t e r 3 : I n t r o d u c t i o n t o E c o n o m i c G r o w t h 29

    that was 146 times as large as Congos.

    Economists use the term poverty to describe low standards of living. A person or family liv-ing in poverty has diffi -culty affording the basic necessities of lifefood, clothing, shelter, and healthand can only dream about automo-biles and television sets. Poverty refl ects low real incomes of individuals and families. According to one defi nition used by international organiza-tions such as the United Nations and the World Bank, an individual was living in poverty in 2000 if his or her annual in-come was less than $570 per year in 1996 prices. The value of $570 per year is a modifi cation of a well-known standard established in the 1980s that viewed the poverty line as an income of $1 per person per day. Therefore, we can refer to $570 per year as the $1-per-day poverty standard.

    The number of persons living in poverty in a country depends on two things. One is the way that the countrys income is distributed among persons; for example, the total income might be distributed nearly evenly, or a small fraction of the population might have most of the income. The second is the countrys aver-age real income, which can be approximated by real GDP per person. If this average is very low, the typi-cal resident will be living in poverty even if income is distributed evenly.

    In practice, the second factora countrys real GDP per personis the most important determinant of the number of people living in poverty. Countries with very low real GDP per person are the ones in which a large fraction of the population lives in pov-erty. Therefore, the data plotted in Figure 3.1 tell us that world poverty in 2000 was dominated by sub-Saharan Africaan amazing 23 of the lowest 25 real GDPs per person were in this region. The two other countries in this poorest group were Yemen (9th from the bottom) and Tajikistan (25th).

    Real GDP per person in 2000 gives us a snapshot of the standard of living at a point in time. The rich coun-tries, such as the OECD members, were rich in 2000 because their levels of real GD