Introduction to Economics strictly speaking, economic growth refers to a process of continuous increase in per capita national income • even though total national income grows, the

Chapter 5 Economic Growth and Economic Development

MACROECONOMICS

Introduction to Economics

contents

Backgrounds

Process of Economic Growth

Growth Accounting

Economic Development

Growth vs Distribution

5.1

5.2

5.3

5.4

5.5

5.1 Backgrounds

• Why economic growth is important?

- economic growth gives us more prosperous lives and more jobs[the recent trend of jobless growth is a worrisome phenomenon]

• major points of interest about economic growth(1) what are the determinants of economic growth and how long high growth

rate can be sustained?(2) what are the causes of income differentials between countries and what are

the reasons why many countries cannot come out of a poverty trap?(3) what policies can be used to promote economic growth?

Long-term Trend of Economic Growth

5.1 Backgrounds

• strictly speaking, economic growth refers to a process of continuous increase in per capita national income

• even though total national income grows, the level of economic wellbeing can go down if such growth was merely due to an increase in population

• according to Prof. Thomas Piketty, the world average of annual growth rates was 0.1% up to the year 1700 and the average rate of population growth was also 0.1% → growth rate of per capita national income was 0%

• the average annual growth rate for the period from 1700 to 1820 was only 0.1%

Long-term Trend of World Economic Growth

5.1 Backgrounds

data: Thomas Piketty, Capital in the Twenty First Century, Belknap, 2014

of population

Industrial Revolution and Economic Growth

5.1 Backgrounds

• economic growth (in the sense of an increase in per capita national income) began to be visible from the period of industrial revolution in the 18th century

• but Britain, the leader of industrial revolution, recorded just 0.5% of average annual growth rate from the end of the 18th century to the beginning of the 19th century

• it was toward the middle of the 19th century that the average rate of growth began to exceed 1% level

• the Netherlands, another superpower at that time even recorded a negative growth rate

Economic Growth Rates of Various Countries

5.1 Backgrounds

data: Angus Maddison, Pbases of Capitalist Development, Oxford University Press, 1982)

The Netherlands

Britain

Britain

North-South Problem

5.1 Backgrounds

(1) low-income countries or developing countries are still struggling

• not all the countries have enjoyed the benefits of economic growth

- low-income countries refer to countries with very low per capita national income due to slow economic growth

- low-income countries whose people constitute 20% of world population have only 1.4% of world income

(2) North-South problem

- the problem of a wide income differential between rich and low-income countries

(3) Question : Is convergence possible?

Per Capita GNI and Economic Growth Rate of Various Countries (2013)

5.1 Backgrounds

data: The World Bank, World Development Indicators, 2013

Growth in Malthusian Economy

5.2 Process of Economic Growth

• labor(L) is the only factor of production assumed• aggregate production curve(AP) with a concave shape

𝒀 = 𝑭 𝑳 ( Y : food production)• law of diminishing return : with the amount of land fixed,

the amount of food we can get by adding one more unit labor becomes smaller and smaller as the level of labor input rises

• subsistence curve𝑺 = 𝒂𝑳 ( 𝒂 : subsistence level of food consumption per person)

Malthusian economy

Malthusian Economy




adjustment process of

Malthusian economy

• if current level of population(L2) > equilibrium level of population(LS) ⇒ amount of food produced (point C) is less than the amount of food necessary for subsistence (point D) ⇒ a decrease in population

• if current level of population(L1) < equilibrium level of population(LS) ⇒ amount of food produced (point A) is more than the amount of food necessary for subsistence (point B) ⇒ an increase in population



Malthusian equilibrium

- in the long-run, Malthusian economy reaches a point where there is no further change in either production or population

- people consume the minimum amount food for subsistence and there is no more change in either production or population

• stationary state

• we get this conclusion because we assume that labor is the only factor of production and labor input is subject to the law of diminishing return

- but, in fact, labor is not the only factor of production- could not anticipate the remarkable pace of technological

progress

Growth in Solow Economy


Solow economy

• in addition to labor, capital is introduced as a factor of production• improvement in labor productivity thanks to capital accumulation

offsets the effect of the law of diminishing return• (for the same amount of labor input) more capital input brings

about an increase in per capita national income • but even capital is subject to the law of diminishing return and

therefore unlimited growth is impossible• steady state : growth has reached its limit and no further increase

in per capita national income • level of economic welfare at steady state is higher than that at

stationary state

Problem of Sustainable Growth


essential element of sustained growth is technological progress

• technological progress encompasses any kind of change which contributes to an improvement in productivity

• economic growth made possible by technological progress is not subject to the law of diminishing return

- in reality, technological progress in one sector spreads to other sectors and, as a result, the pace of technological progress can get even quicker

• continuous technological progress makes sustained growth possible- but growth enabled by population increase and capital accumulation

reaches its limit at some point

Quantitative growth and qualitative growth

5.3 Growth Accounting

•quantitative growth

- growth made possible by mobilizing more labor and capital without an improvement in technological level

•qualitative growth

- growth made possible by an improvement in technological level

•growth accounting

- work to decompose actual growth into quantitative growth and qualitative growth


economic growth of

East Asian countries

• four dragons (Korea, Hong Kong, Singapore, Taiwan)

• their miraculous growth has been found to be mostly quantitative growth (high savings rate and long work hours)

* in case of Korea, the portions of quantitative growth and qualitative growth were 8.6% point and 1.7% point respectively

Growth Accounting and Asian Miracle


economic growth of

East Asian countries

•limitation of quantitative growth- due to the law of diminishing marginal product, unlimited

growth is impossible- also difficult to increase the input of labor or capital endlessly- qualitative growth is desirable, but we should not ignore the

importance of quantitative growth

* at early stages of economic development, the pursuit of quantitative growth could be a sensible strategy

Growth Accounting and Asian Miracle


Growth Accounting

footnote: For 4 Asian Countries, A. Young, “The Tyranny of Numbers: Confronting the Statistical Realities of the East Asian Growth Experience”, Quarterly Journal of Economics(1995). For the U.S. E. Denison, Accounting for Slower Economic Growth: The United States in the 1970s, Brookings institution(1979).

5.4 Economic Development

economic development

• economic development means more than just an increase in per capita national income because it also encompasses the improvement in rationality and efficiency of the economy

• for developing economies to join the rank of rich countries, they should succeed in structural reforms

• in practice, it is difficult to distinguish between economic growth and economic development

• the construction of social overhead capital(SOC) requires a lot of funds, but most developing countries are short of such funds

• vicious circle of low income, low savings rate, and low level of investment

- difficult to attract foreign investments due to low international credit ratings and political instability


(1) insufficiency of investment funds

Barriers to Economic Development



• high population growth rate is one of main causes of slow capital accumulation

• despite fast population growth, supply of skilled labor is insufficient

(2) high population growth rate and insufficient human capital


(3) market failure

- surplus labor in the agricultural sector cannot move to the industrial sector easily

• inefficient allocation due to underdeveloped capital markets

• property rights not well protected → hard to realize capitalistic development based on the pursuit of profit


(4) political instability

•underdeveloped labor markets


Problem of Development Strategy

industrial policy

• industrial policy refers to preferential government support of specific industries with high growth potentials

• various tax preferences, subsidies and preferential lendings• theory of unbalanced growth by A. Hirschman

- theoretical backgrounds of industrial policy - intensive investment in industries with high growth

potentials• argument of the protection of infant industry by F. List

- it argues that temporary protection of domestic industries which have just started is necessary until they achieve competitiveness


Industrial Policy

criticism of industrial

policy

• if a certain industry has high growth potentials, businessmen will invest in that industry voluntarily

• various kinds of side effects can occur- Is government capable of selecting appropriate

industries worth supporting?* meddling of interest groups or political compromises possible

- once started, difficult to stop supporting- sacrifice of other industries is also a problem

* arbitrary redistribution of income


Export-led Growth Strategy and Import Substitution Growth Strategy

export-led growth

strategy

• based on the idea that priorities should be given to export industries so that they can play the leading roles for the development of other industries

• emphasize the importance of development of export markets• can contribute to the improvement in efficiency through

economies of scale and competition with foreign firms• but too much emphasis on short-run gains may be detrimental

to the long-run growth potentials • imbalance between industries and increased dependence on

foreign markets could be a problem


Export-led Growth Strategy and Import Substitution Growth Strategy

- to enhance self-sufficiency, priorities are given to industries which can substitute imports

- development of domestic markets emphasized

• import substitution growth strategy

- more openness means more rapid growth- examples of Korea, Japan, Taiwan, Hong Kong, and Singapore

• summarizing the experiences of development of many countries, we can conclude that performances of export-led growth strategy are relatively better

5.5 Growth vs Distribution

• there has been much discussion about the issue of what should be more emphasized between growth and distribution

• the argument that growth should be more emphasized seems to get more support

• Kuznets hypothesis explains that in early stages of economic growth the state of distribution tends to get worse

• it says that when economic growth reaches a certain stage the trend of equalization begins to appear ⇒ inverted U hypothesis

Kuznets hypothesis


• in early stages of economic growth, income is concentrated in a few businessmen who plays the leading role in the growth process

• besides, government policies tend to accelerate the concentration of incomeex) pro-business policies to fasten the pace of growth

• it is in a later stage that laborers begin to share the fruits of growth • hence it might be difficult to pursue the objectives of growth and

distribution from the beginning


• some argues that a state of somewhat unequal distribution is beneficial for growth

• for economic growth to materialize, capital should be accumulated fast

• it is argued that the state that wealth is concentrated in a few rich people is advantageous for fast accumulation of capital (since the marginal propensity to consume of the rich is lower)

• argument about the issue of what should be more emphasized between growth and distribution is based on the preconception that growth and distribution are incompatible

• Question : Are growth and distribution really incompatible?


Re-examination of Kuznets Hypothesis

• in view of historical experiences, it is not true that a reversal to equalization begins to happen in an economy which reaches a certain stage of maturity

• recently inequality in distribution seems to get worse in many rich countries including the U. S.

• a reversal to equalization might have just happened to appear during the period of time that Kuznets analyzed

• there is no logical ground that the state of distribution follows the path that Kuznets suggests

• Question : What was the reason that the U. S. society began to show the trend of equalization in the 1930s?


Re-examination of Kuznets Hypothesis

• income distribution in the U. S. continued to become more unequal up until the 1920s

• the trend of widening inequality got a hit by the great turmoil caused by Great Depression in the 1930s

• in addition, New Deal by President F.D.Roosevelt initiated the trend of rapid equalization

• in the U. S. history, the period from the 1940s to the 1960s is called the period of Great Compression


Re-examination of Kuznets Hyphothesis

• we cannot say that the period of Great Compression began at that time just because the U. S. economy reached the stage of economic growth that Kuznets said a reversal to equalization would begin

• Without the New Deal which pursues actively more equal distribution, the trend of equalization would not get started

• from the late 1970s the foundations of the New Deal began to be destroyed and we saw a reversal to inequality


• the view that growth and distribution are incompatible is based on the thought that efficiency and equity are in a conflicting relationship

• this thought about the relationship between efficiency and equity might be correct from a short-run perspective, but wrong from a long-run perspective

• in the long-run, social capital such as trust, voluntary co-operation, teamwork is an essential driving force of growth

• too much emphasis on growth while neglecting distribution is detrimental to the accumulation of social capital


• recent studies on the relationship between growth and distribution have found out that countries with relatively equitable distribution tend to record higher growth rates

• this finding suggests that neglecting distribution to focus on growth might result in a slow-down of growth

• growth and distribution should not be seen as a problem of choice, but as a problem of harmony

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Introduction to Economics strictly speaking, economic growth refers to a process of continuous increase in per capita national income • even though total national income grows, the

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