Chapter 4
ECONOMIC GROWTH
NGUYEN BICH DIEP, PhD
[email protected]
Economic growth
Economic growth is the process by which a nation’s wealth increases over time.
Economic growth is often measured by increase in real GDP or increase in real
GDP per capita.
Exercise
Indicator 2015 2016 2017 2018
Real GDP (mil. $) 11,000 13,000 13,500 15,000
Population (mil.) 8.23 8.30 8.74 8.87
Real GDP per capita 1337 1566 1545 1691
Real GDP growth rate (%) - 18.18 3.84 11.11
Real GDP per capita - 17.18 -1.38 9.48
growth rate (%)
Economic development
Economic development is the process by which a simple, low-income economy
is transformed into a modern industrial economy.
It is broader than economic growth and involves qualitative and quantitative
improvements. It is typically associated with improvements in a variety of areas,
such as education, health,…
The power of sustained economic growth
Formular for calculating future GDP at a given growth rate:
Rapid rates of economic growth can bring profound transformation.
The power of sustained economic growth
Value of an Value of an Value of an
Growth rate original 100 in original 100 in original 100 in
10 years 25 years 50 years
1% 110 128 164
3% 134 209 438
5% 163 339 1,147
8% 216 685 4,690
Labor productivity
Sustained long-term economic growth comes from increases in worker
productivity.
Labor productivity is the value that each employed person creates per unit of
their input.
A common measure of productivity per worker is the monetary value per hour
the worker contributes to the employer’s output.
Determinants of labor productivity
Physical capital per worker: Physical capital is the stock of equipment and structures
used to produce goods and services
Human capital per worker: Human capital is the knowledge and skills that workers
acquire through education, training, and experience.
Natural resources per worker: Natural resources are inputs into production that are
provided by nature, such as land, rivers, and mineral deposits. Natural resources take
two forms: renewable and non-renewable.
Technological knowledge: the understanding of the best ways to produce goods and
services.
Growth accounting studies
Growth accounting studies aim to determine the extent to which physical and
human capital deepening and technology have contributed to growth.
The usual approach uses an aggregate production function to estimate how
much of per capita economic growth can be attributed to growth in physical
capital and human capital. These two inputs can be measured at least roughly.
The part of growth that is unexplained by measured inputs, called the residual, is
then attributed to growth in technology.
Growth accounting studies
Three lessons commonly emerge from growth accounting studies:
First, technology is typically the most important contributor to economic growth.
Second, while investment in physical capital is essential to growth in labor
productivity and GDP per capita, building human capital is at least as important.
Third, these three factors of human capital, physical capital, and technology work
together.
Economic convergence
Convergence: Some low-income and middle-income economies grow faster than
those of high-income countries.
Arguments favoring convergence
Diminishing marginal returns: The law of diminishing returns suggests that as an
economy continues to increase its human and physical capital, the marginal
gains to economic growth will diminish.
“The advantages of backwardness”: High-income countries must continually
invent new technologies, whereas low-income countries can often find ways of
applying technology that has already been invented and is well understood.
Many countries have observed the experience of those that have grown more
quickly and have learned from it.
Arguments that convergence is neither
inevitable nor likely
Developing new technology can provide a way for an economy to sidestep the
diminishing marginal returns of capital deepening.
In theory, perhaps, low-income countries have many opportunities to copy and
adapt technology, but if they lack the appropriate supportive economic
infrastructure and institutions, the theoretical possibility that backwardness
might have certain advantages is of little practical relevance.
The slowness of convergence
Consider a country that starts off with a GDP per capita of $40,000, which grows
at an annual rate of 2%.
Another country that starts out at $4,000 and grows at the aggressive rate of 7%
per year.
After 30 years, GDP per capita in the rich country will be $72,450 while in the
poor country it will be $30,450. Even after 30 consecutive years of very rapid
growth, however, people in the low-income country are still likely to feel quite
poor compared to people in the rich country.
The slowness of convergence
Moreover, as the poor country catches up, its opportunities for catch-up growth
are reduced, and its growth rate may slow down somewhat.
The high-income countries have been building up their advantage in standard of
living over decades or even more than a century. It will take decades for the low-
income countries to catch up significantly.
