Economic Growth

This is Unit Four of Principles of Macroeconomics: economic growth. Unit three measured output; this unit asks what makes it rise over decades rather than quarters. Carry one idea through. Growth in living standards comes from productivity and nothing else in the long run, and productivity comes from capital, skills and technology. But the inputs alone do not produce growth, and the last entry shows two countries where they went in and it did not follow. By the end you will compute compound growth, use the rule of seventy-two, tell productivity growth from a participation effect, tell capital deepening from technological change, and judge whether a policy raises the long-run path.

Three entries on how recent sustained growth is, and how fast it has run.

How recent growth is.

MAC 0301 Modern Economic Growth Is Recent

Sustained growth in living standards is recent. For most of history output per person barely moved, and the change began about two centuries ago: a medieval peasant and a Roman farmer lived at roughly the same level. Growth is the exception in human history, not the normal condition.

What started it.

MAC 0302 The Industrial Revolution

The Industrial Revolution was the spread of power-driven machinery from the early eighteen hundreds: the steam engine, the power loom, the locomotive. It began in Britain and spread to the United States and Germany, starting a cycle in which invention drew investment, investment produced profit, and profit funded more invention.

How fast growth has run.

MAC 0303 Two Percent a Year

The leading industrial economies have grown about two percent a year per person for two centuries. That sounds small and is not: two percent multiplies income roughly sevenfold over a century. Because growth compounds, a gap of one percentage point becomes enormous over decades.

Two entries on the arithmetic that makes those rates matter.

Doing the arithmetic.

MAC 0304 Compound Growth

To find a value after several periods of steady growth, multiply the starting value by one plus the rate, raised to the number of periods. Write the rate as a decimal, so three percent gives a factor of one point zero three. The formula runs backwards: dividing the ending value by the starting value and taking the appropriate root gives the average rate. One hundred growing at three percent for twenty-five years reaches about two hundred and nine, where simple multiplication would predict one hundred and seventy-five. Use real rates, or the answer measures inflation too.

A shortcut for the same question.

MAC 0305 The Rule of 72

The rule of seventy-two gives doubling time without a calculator: divide seventy-two by the growth rate stated as a whole number. It works for anything growing at a steady percentage rate, and is most accurate between about two and ten percent. At two percent income doubles in about thirty-six years, roughly twice in a lifetime; at six percent in about twelve, about six times. The rule is rough on purpose, so treat the answer as an estimate.

Three entries on where growth actually comes from.

The source of growth.

MAC 0306 Labor Productivity

Labor productivity is output per worker, or per hour worked, and sustained growth in living standards comes from productivity growth and nothing else in the long run. Three things raise it: human capital, better technology, and economies of scale. Productivity also sets wages, because employers can pay about what a worker produces.

A distinction worth keeping.

MAC 0307 Productivity or Participation?

GDP per capita rises for two reasons: each worker producing more, which is productivity growth, or a larger share of the population working, which is a participation effect. To tell which, compare output per worker with output per person. A country whose output per person rises ten percent over a decade while output per hour is unchanged has added workers, not productivity. That can happen once, but a participation rate cannot pass one hundred percent, so the source runs out. This is why an aging population worries economists.

The relationship behind it.

MAC 0308 The Aggregate Production Function

The aggregate production function relates the economy's inputs to its output. Adding more of one input while others are fixed raises output, but by less each time: diminishing marginal returns, since each extra worker has less capital to work with. Better technology shifts the whole function upward.

Four entries on the inputs themselves.

The first of the inputs.

MAC 0309 Physical Capital

Physical capital is plant, equipment and infrastructure: the produced things workers use to produce. More of it and better of it both raise productivity, and roads, ports and power grids count alongside machines. Capital wears out, so some investment each year only replaces what depreciated.

The input carried in people.

MAC 0310 Human Capital

Human capital is the knowledge, skill and experience workers bring, built by investing now and repaid later: a year in school costs a year of earnings and raises earnings for decades. Growth accounting finds it at least as important as physical capital, which is why rebuilt economies recover faster than destroyed ones.

The input that is not a thing.

MAC 0311 Technology: Invention and Innovation

Technology is anything that makes the same inputs produce more. Invention is the advance in knowledge, innovation is putting it to work, and the transistor was invented in nineteen forty-seven and took years to reach products. Technology includes ways of organizing work: the assembly line raised output with no new machine in it.

Giving each worker more.

MAC 0312 Capital Deepening

Capital deepening is more capital per worker, physical or human, moving the economy along its production function toward higher output per worker. More machines per worker and more schooling per worker both count. Because of diminishing returns, deepening alone cannot raise growth forever.

Four entries on telling deepening from technology, and what growth costs.

Telling the two apart.

MAC 0313 Capital Deepening or Technological Change?

Both raise output per worker, and the test is whether the economy moved along its production function or the function itself moved. Deepening gives each worker more of the same input, so the economy travels up the existing curve and meets diminishing returns. Technological change lets the same inputs produce more, shifting the whole curve upward. A second identical machine per worker is deepening; software letting existing machines run without stopping is technological change. The two are hard to separate, because new capital usually arrives with new technology built into it.

How that is measured.

MAC 0314 Growth Accounting

Growth accounting measures how much of growth the counted inputs explain and attributes the leftover to technology, and that leftover is usually the largest share. American studies put input quantity at roughly two thirds of growth. The residual is what the method could not measure, so calling it technology is an inference.

What growth costs.

MAC 0315 Growth Requires Forgoing Consumption

Building capital means producing something other than consumer goods, so growth is paid for by consuming less now, and saving frees the resources. A student giving up wages to study makes exactly this trade. This is unit one's opportunity cost at national scale.

A worry about machines.

MAC 0316 Does Technology Destroy Jobs?

New machines displace particular workers, and the common conclusion is that technology reduces employment overall. Across an economy the evidence runs the other way: through industrialization employment more than doubled and real wages rose despite heavy immigration. The displacement is real and local; the net effect is not.

Three entries on the setting growth needs.

The rules that let it work.

MAC 0317 Institutions, the Rule of Law and Property Rights

Institutions are the laws and traditions by which a community governs itself, and the rule of law means laws that are clear, public, fair, enforced, and applied to everyone. Property rights let owners use what is theirs. Without enforcement, trade and investment shrink, because nobody commits resources they may not keep.

What else the setting needs.

MAC 0318 A Climate for Growth

Growth needs a setting that rewards investment in capital, skills and technology: stable rules, openness to trade, and a government role where markets fall short. Schooling, infrastructure, research support and patent protection are the usual instruments. Which of them work, and how far tax policy belongs among them, is contested, and this course reports the dispute rather than settling it.

Choosing between policies.

MAC 0319 Which Policy Raises Long-Run Growth?

Long-run growth comes from productivity, so a policy raises it only by adding to human capital, physical capital or technology, or by improving the institutions that let those pay off. Test any option against that list. Among higher education spending, a year of lower interest rates, higher tariffs, and a one-off household rebate, only the first adds to an input productivity depends on. The distinction that decides these questions is short run against long run: a policy can be right for a recession and irrelevant to growth.

Five entries on whether poorer countries close the gap.

Whether the gap closes.

MAC 0320 Convergence

Convergence is the idea that poorer economies grow faster than richer ones, so incomes move together over time. Some economies have converged sharply; others have not moved toward the leaders at all. A claim about total growth is not a claim about convergence.

The case for it.

MAC 0321 Why Convergence Might Happen

Two forces push toward convergence. Capital pays more where it is scarce, so investment does more in a poor country. And copying existing technology is cheaper than inventing it, so a country can skip the decades spent discovering it. That second force has a name: the advantages of backwardness.

The case against.

MAC 0322 Why Convergence Is Not Guaranteed

Rich economies keep moving. New technology shifts their production function upward, offsetting the diminishing returns that would otherwise let others catch up, and ideas can be used again at almost no extra cost. Adopting technology also needs institutions that support it, which is why identical investment produces different results in different countries.

Judging a convergence claim.

MAC 0323 Reading a Convergence Claim

Convergence claims go wrong in three predictable ways. Is growth measured per person or in total? A populous country can lead the world in total growth while its people gain slowly. Over what period? Claims are sensitive to the decade chosen. And how fast? Take a rich country at forty thousand growing two percent and a poor one at four thousand growing seven. After thirty years they reach about seventy-two thousand and about thirty thousand: the ratio falls from ten to about two and a half, and the gap in dollars is still over forty thousand.

What the question comes to.

MAC 0324 Will Poor Countries Catch Up?

Here the unit's governing idea is at work. The case for convergence rests on two arguments: capital earns more where it is scarce, so a given investment raises output more in a poor country, and a country behind can adopt technology already proven elsewhere without paying to discover it. Together they predict the gap should close on its own. The case against is equally serious. The leaders are not standing still, new technology keeps shifting their production function upward, and ideas, unlike machines, can be used again at almost no extra cost. And technology does not transplant by itself: it needs the institutions, the skills and the rule of law that let it be used. Between nineteen sixty and nineteen eighty-five, capital per worker rose more than fivefold in both Gambia and Japan, while output per worker rose two percent in the first and two hundred and sixty percent in the second. The inputs went in; the growth did not follow. South Korea, among the poorest economies after its war, reached high income within four decades through universal schooling, investment of about a third of output, and technology acquired from abroad. Three cautions. Convergence is not a law but a tendency, appearing in some periods and countries and not others. The evidence that inputs alone do not produce growth is the strongest single finding here. And the honest conclusion is uncomfortable: the recipe is known in outline, yet knowing it has not been enough to make it happen on request.

Look at what you can now do. You can compute a value after years of compound growth, multiplying by one plus the rate raised to the number of years, and using real rates. You can use the rule of seventy-two for a doubling time, treating the answer as the estimate it is. You can tell productivity growth from a participation effect by comparing output per worker with output per person. You can tell capital deepening from technological change by asking whether the economy moved along its function or the function moved. And you can judge whether a policy raises the long-run path, by testing it against capital, skills, technology and the institutions that reward all three. Unit five turns to how unemployment is counted.