7 CHAPTER D YNAMIC P OWER P OINT ™ S LIDES BY S OLINA L INDAHL The Wealth of Nations and Economic Growth.

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DYNAMIC POWERPOINT™ SLIDES BY SOLINA LINDAHLThe Wealth of The Wealth of Nations and Nations and

Economic GrowthEconomic Growth

CHAPTER OUTLINE

Key Facts about the Wealth of Nations and Economic Growth

Understanding the Wealth of Nations

Incentives and Institutions

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To Try it! To Try it! questionsquestions

Some good blogs and other sites to get the juices flowing:

Food for Food for Thought….Thought….

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Economic growth is a matter of life and death to the 1.8 million children who die of diarrhea each year globally.

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Key Facts about the Wealth of Nations and Economic Growth

Fact One: GDP per Capita Today Varies Enormously among Nations

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Key Facts about the Wealth of Nations and Economic Growth

Wealth and Health go Together. Source: Penn World Tables and World Bank Group, World Development Indicators, 2005

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Key Facts about the Wealth of Nations and Economic Growth

Fact Two: Everyone Used to be Poor

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Key Facts about the Wealth of Nations and Economic Growth

A Primer on Growth RatesHow is economic growth measured?

Where yt is per capita real GDP in year t

Example: Year real GDP per capita

2008 $15,000 2009 $15,500

100y

yyg

1t

1ttt

%33.3100000,15

000,15500,152009

g

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The Rule of 70 (The Magic of Compounding)

The rule of 70:

Example: If real GDP per capita is growing at an annual growth rate of 3.5%, it will double in:

The moral? Small improvements in growth add up fast (the power of compounding).

% 70

time Doublinginrategrowth

years. 20 5.3

70

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A Little Growth Goes a Long Way

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Key Facts about the Wealth of Nations and Economic GrowthFact Three: There are Growth Miracles and Growth Disasters

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Understanding the Wealth of Nations

The Factors of Production are important

Physical capital:Physical capital: the stock of tools including machines, structures, and equipment.

Human capital:Human capital: is the productive knowledge and skills that workers acquire through education, training and experience.

Technological knowledge:Technological knowledge: knowledge about how the world works that is used to produce goods and services.

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What Causes Economic Growth?

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Understanding the Wealth of Nations

Why do some nations have faster growth than others?

Besides factors of production, incentives and institutions matter.

InstitutionsInstitutions = “rules of the game” that structure economic incentives.

Institutions of Economic Growth1. Property rights2. Honest government3. Political stability4. A dependable legal system5. Competitive and open markets

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Korea’s Experiment

Before division after WWII: similar

Culture, physical capital, technology.

North Korea became a communist state with a centrally planned economy.

South Korea adopted the capitalist free market model.

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North and South Korea at night

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Institutions

1.Property rights:

Provide incentives to work hard.

Encourage investment and innovation.

Without property rights:

Effort is divorced from payment, reducing incentives.

Free riders become a problem.

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Institutions

Free Rider Free Rider = someone who consumes a resources without working or contributing to the resource’s upkeep.

China’s “Great Leap Forward”- which introduced farming collectives- reduced incentives. 20-40 million starved.

1978, farmers in Xiaogang met in secret to devise a plan to keep some of their produce. (background photo)

Productivity improved so quickly the government allowed the experiment to proceed.

Food production increased 50% in 5 years 1978-1983.

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Institutions

2. Honest Government

Property rights are meaningless unless government guarantees property rights.

Corruption bleeds resources away from productive entrepreneurs.

Corruption takes resources away from more productive government activity.

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Corruption and Growth Don’t go Together

Source: Penn World Tables and World Bank Group, World Development Indicators, 2005

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Corruption Who’s Who List

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Institutions

3.Political Stability

Changing governments without the rule of law creates uncertainty which leads to less investment in physical and human capital.

In many nations civil war, military dictatorship, and anarchy have destroyed the institutions necessary for economic growth.

Bullet casings from Liberia’s Civil War: Bad soil for anything to grow.

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Institutions

4.Dependable Legal System

A good legal system facilitates contracts and protects property from others (including government).

Poorly protected property rights can result from too much government or too little government.

In India, residents who purchase land have to do so more than once because of lack of proper record keeping.

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Institutions

5.Competitive and Open Markets

Encourage the efficient organization of resources.

One study found: if India used its physical and human capital as efficiently as the U.S., India would be 4x richer than it is today.

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Institutions

Why do poor countries use their capital inefficiently?

Whether inadvertently or not, inefficient and unnecessary regulations:

Create monopolies and impede marketsExample: until recently in India, it was illegal to produce shirts using large-scale production

Economies of scale Economies of scale = the advantages of large-scale production that reduce average cost as quantity increases

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Institutions and Growth Miracles Revisited

Why did England’s Industrial Revolution bring us:

large scale factories mass production the steam engine the railroad the beginnings of a consumer society the first sustained rise in human

living standards above subsistence?

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Institutions and Growth Miracles Revisited

Property rights?England’s geography and Navy helped protect property rightsHonest governmentGrowth of Parliament (and religious changes) reduced royal tyrannyPolitical stabilityMiddle class developed from growthA dependable legal systemLess corruption as royal and Catholic power is reducedCompetitive and open marketsEngland opened itself more to trade