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.
A country’s standard of living depends on its ability to produce goods & services.
This ability depends on productivity - the average quantity of goods and services produced from
each hour of a worker’s time.
Y = real GDP = quantity of output produced
L = quantity of labour
Y/L= productivity (output per worker)
- When a nation’s workers are very productive, real GDP is large and incomes are high.
- When productivity grows rapidly, so do living standards.
- The large differences in living standards we observe across countries or over times, we must
focus on the prediction of goods an services
Determinants of Productivity
Physical Capital Per Worker
- [physical] capital (K) - The stock of equipment and structures used to produce goods &
K/L = capital per worker
- Productivity is higher when the average worker has more capital (machines, equipment, etc.)
– factors of production
- capital is an input into the production process that in the past was an output from the
- an increase in K/L causes an increase in Y/L.
Human Capital Per Worker
- Human capital (H): the knowledge and skills workers acquire through education, training,
H/L = the average worker’s human capital
- Productivity is higher when the average worker has more human capital (education, skills,
- Human capital includes the skills accumulated in early childhood programs, grade school,
high school, college or university, and on-the-job training for adults in the labour force
- an increase in H/L causes an increase in Y/L
- Knowledge is the quality of society’s textbooks, whereas human capital is the amount of time
that the population has devoted to reading them. Workers’ productivity depends on both the
quality of textbooks they have available and the amount of time they have spent studying
Natural Resources Per Worker
- Natural resources (N): the inputs into production that nature provides, e.g., land, mineral
- Other things equal, more N allows a country to produce more Y
- In per-worker terms, an increase in N/L causes an increase in Y/L
- Some countries are rich because they have abundant natural resources (e.g., Saudi Arabia
has lots of oil).
- But countries need not have much N to be rich (e.g., Japan imports the N it needs).
- Technological knowledge (A): society’s understanding of the best ways to produce goods
- Technological progress does not only mean a faster computer, a higher-definition TV, or a
smaller cell phone.
It means any advance in knowledge that boosts productivity (allows society to get
more output from its resources)
E.g., Henry Ford and the assembly line. Economic Growth and Public Policy
1. Saving and Investment
- We can boost productivity by increasing K, which requires investment.
- Since resources are scarce, producing more capital requires producing fewer consumption
- Reducing consumption = increasing saving. This extra saving funds the production of
investment goods. (More on this in the next chapter.)
- Hence, a tradeoff between current and future consumption. 2. Diminishing Returns and the Catch-Up Effect
- Diminishing Returns: the property whereby the
benefit from an extra unit of an input declines
as the quantity of the input increase
- The government can implement policies that
raise saving and investment.
- Then K will rise, causing productivity and living
standards to rise.
- But this faster growth is temporary,
due to diminishing returns to capital:
As K rises, the extra output from an additional
unit of K falls
- Over 1960-
and S. Korea devoted a similar share of GDP to investment,
so you might expect they would have similar growth
- But growth was more than 6% in Korea and only 2.5% in
- Explanation: the catch-up effect.
In 1960, K/L was far smaller in Korea than
in Canada, hence Korea grew faster
3. Investment from Abroad
- raise K/L and hence productivity, wages, and
living standards, the govt can also encourage
- foreign direct investment: a capital investment (e.g., factory) that is owned & operated by
a foreign entity
- foreign portfolio investment: a capital in