CHAPTER 24 (8)
GROWTH, PRODUCTIVITY, AND THE WEALTH
OF NATIONS

LAUGHER CURVE
We have two classes of forecasters:
Those who don't know, and those who don't know they don't know.
John Kenneth Galbraith
______________________________________________________________________________
CHAPTER OVERVIEW: What’s It All About?
This chapter presents a detailed description of economic growth beginning with Adam Smith and
bringing it up to the present time. Modern thinking has changed from the pessimistic view that
growth is limited to a new optimism – that technological growth creates unlimited growth
potential. What are the factors that promote growth? These factors include: (1) investment and
accumulated capital, (2) available resources, (3) institutions and incentives compatible with
growth, (4) technological development, and (5) entrepreneurship. Classical and new theories of
growth are explained. The chapter concludes with a discussion of economic policies that
encourage per capita growth. These include: (1) saving and investment, (2) controlled population
growth, (3) increased the level of education, (4) creation of institutions that encourage
technological innovation, (5) funding basic research, and (6) increasing openness to trade.
CHAPTER OBJECTIVES: Students Should Be Able To …
1. Define growth and relate it to living standards. Growth is an increase in the amount of
goods and services an economy produces. Long-term growth rates matter a lot because of
compounding. This means that growth is based not only on original levels of income in a
country, but also on the accumulation of previous years’ increases in income.
2. List five sources of growth. Economists have five important sources of growth: (1) capital
accumulation – investment in productive capacity, (2) available resources, (3) institutions
with incentives compatible with growth, (4) technological development, and (5)
entrepreneurship.
3. Distinguish diminishing marginal productivity from decreasing returns to scale. The law of
diminishing marginal productivity states that increasing one output, keeping all others
constant, will lead to smaller and smaller gains in output. Decreasing returns to scale occurs
if output rises by a smaller proportionate increase as all inputs.
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Chapter 24 (8): Growth, Productivity, and the Wealth of Nations
4. Distinguish Classical growth theory from new-growth theory. The Classical growth model
focused on capital accumulation in the growth process. Growth theory separates investment
in capital from investment in technology.
5. List and discuss six government policies to promote growth. These include: (1) saving and
investment, (2) controlled population growth, (3) increase the level of education, (4) create
institutions that encourage technological innovation, (5) fund basic research, and (6) increase
openness to trade.
WHAT’S NEW? Revisions to This Edition
This chapter remains roughly the same as in last edition. Two new boxes are added: (1)
aggregate demand as a possible determinant to growth, and (2) the long-term effects of terrorism
on growth. One small change is that the discussion of growth refers to the production possibility
curve so that students can see the continuity between chapters. Effects of 9-11 on long-term
growth is discussed in a box, “Applying the Tools: Growth and Terrorism.”
DISCUSSION STARTERS: Get Your Class Rolling
1. Is economic growth good? Should public policy promote economic growth? Is there any
downside to economic growth?
2. If per capita real GDP goes up, is the average person in that nation better off? Why or why
not?
3. The issue of population growth has caught the public’s imagination. Most public
commentators deplore it. Can you think of any arguments in favor of population growth?
4. Patents and copyrights backed by law create monopolies – some temporary and some
relatively permanently. What effect do these have on the health and economic development
of emerging nations?
5. Is increasing educational opportunity to individuals good for economic growth? How can
politicians argue for more public education and at the same time argue for strong
environmental issues?
TIPS FOR TEACHING LARGE SECTIONS
Growth
I give students a sense of compound growth in the following way: At the beginning of
class, I pass out a sheet of paper with numbers on each row equal to the number of people in the
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Chapter 24 (8): Growth, Productivity, and the Wealth of Nations
class. I ask people to sign their name and to double the amount that is on the previous line. The
first line starts with one cent. I then ask students to write down what they believe the total
amount will be at 20 students, 40 students, etc. At the end of the class I compare their
predictions, which are inevitably low, with the actual number on the sheet. During the lecture, I
periodically call on someone to say where we are now. The exercise serves to keep the students’
attention, and to give me an attendance sheet for the day.
ON THE WEB: Integrating New Media into the Classroom
http://www.sti.nasa.gov/tto/ is the Web site of NASA’s Center for AeroSpace Information
Technology Transfer Office. “The secondary use of NASA technology and its impact on the
economy and global competition has been facilitated through [this program]. This mechanism is
employed to transfer new technologies developed in the course of NASA activities to the public
and private sector.” This spurs growth. Politics: bureaucratic, self-congratulatory.
http://www.immigrationforum.org/index.htm is the Web site of the National Immigration Forum,
an organization whose purpose is “to embrace and uphold America’s tradition as a nation of
immigrants. The Forum advocates and builds public support for public policies that welcome
immigrants and refugees and that are fair and supportive to newcomers in our country.” Politics:
advocative.
http://ins.usdoc.gov/graphics/index.htm is the Web site of the Department of Justice’s
Immigration and Naturalization Service. Links include: INS Forms, Fees, and Fingerprints;
Immigration Services and Benefits; Law Enforcement and Border Management; Field Offices;
Laws, Regulations, and Guides; and Public Affairs. Politics: bureaucratic.
http://www.odci.gov/cia/publications/factbook is the Web site for the Central Intelligence
Agency’s The World Fact Book. Virtually every nation in the world can be accessed with links
to Country Listing, Reference Maps, and Notes and Definitions. Politics: bureaucratic,
authoritative.
http://www.newdream.org/main/about.html is the Web site of the Center for a New American
Dream, a not-for-profit organization that: “helps Americans consume responsibly to protect the
environment, enhance quality of life, and promote social justice.” The old “dream” focused on
acquisition and consumption. They offer statistics showing how much Americans consume and
how much we pollute. They do not highlight statistics that show how much we produce for
ourselves and the world. Politics: liberal, environmental, slanted.
http://www.rprogress.org is the Web site of Redefining Progress, an environmental-friendly
organization. This is similar to New American Dream. Politics: liberal, environmental,
advocative.
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http://datacentre.chass.utoronto.ca/pwt/index.html is the Web site of the University of Toronto’s
Penn World Tables. Version 5.6 of the Tables comprises data for 152 nations and 29 economic
and environmental subjects. Politics: scholarly, neutral.
STUDENT STUMBLING BLOCKS: Common Areas of Difficulty
The Magic of Compound Interest and the Rule of 72: An In-Class Demonstration.
This demonstration shows the power of compounding using interest. The factor payment of
capital funds (borrowed money) is interest. Simple interest is an interest charge computed by
applying the percentage rate of interest to the principal of the loan only. See the following table
based on a deposit of $1,000 in a savings account paying 10 percent simple interest payable once
a year.
A $1,000 INVESTMENT EARNING INTEREST AT 10 PERCENT. SIMPLE INTEREST
Interest the
Beginning of
Principal +
Principal Earns
Principal Plus
End of Year
Year
@ 10% =
Total Interest
1
$1,000
$100
$1,100
1
2
1,000
100
1,200
2
3
1,000
100
1,300
3
4
1,000
100
1,400
4
5
1,000
100
1,500
5
6
1,000
100
1,600
6
7
1,000
100
1,700
7
8
1,000
100
1,800
8
9
1,000
100
1,900
9
10
1,000
100
2,000
10
Note that it will take the initial investment ten years to double.
We will now switch to an investment paying compound interest. Compound interest is computed
by applying the percentage rate of interest not only to the principal but to the accumulated
interest as well. See the following table:
A $1,000 INVESTMENT EARNING INTEREST AT 10 PERCENT.
COMPOUNDED ANNUALLY
Interest the
Interest the
Principal
Interest
Principal
Beginning of
Earns @
Earns @
Plus Total
Year
Principal +
10% +
10% =
Interest
End of Year
1
$1,000.00
$100
0
1,100.00
1
2
1,100.00
100
$10.00
1,210.00
2
3
1,210.00
100
21.00
1,331.00
3
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Chapter 24 (8): Growth, Productivity, and the Wealth of Nations
4
5
6
7
8
9
10
1,331.00
1,464.10
1,610.51
1,771.56
1,948.72
2,143.59
2,357.95
100
100
100
100
100
100
100
33.10
46.41
61.05
77.16
94.87
114.36
135.79
1,464.10
1,610.51
1,771.56
1,948.72
2,143.59
2,357.95
2,593.74
4
5
6
7
8
9
10
Note that by the end of the tenth year, the account balance is $2,593.74. This is the sum of
$1,000 the principal earned plus another $593.74 the interest earned.
Note also that if the $1,000 is left in the compound interest account, it will double between the
seventh and eighth year. There is a quick rule-of-thumb shortcut to determine how long it will
take to double a sum of money at a given interest rate with annual compounding: divide 72 by the
rate. For example, an investment yielding 8 percent per annum will double in about nine years
(72 divided by 8).
Compound interest has confused, bored, and impressed many over the years. John Maynard
Keynes called it magic. A wag called it the closest thing in life to having our cake and eating it
too. Benjamin Franklin said it best: “Money makes money. And the money money makes also
makes money.” He knew what he was talking about. When he died in 1790, he left ₤1,000
(about $4,600) to the cities of Boston and Philadelphia with the condition that they not touch the
money for 100 years. Boston’s bequest ballooned to $332,000 by 1890.
A colleague of mine taught night classes at our college for extra pay. He socked every nickel of
it into his credit union and never touched it. When he retired 31 years later, he had accumulated
$550,000 in that account!
Keynes was right – it’s magic!
TIES TO THE TOOLS: Bringing the Boxes into the Classroom
Beyond the Tools: Is Growth Good?
Not all economists support unlimited growth. The wrong kind of growth could produce
undesirable side effects including global warning, polluted rivers, and waste. Rich countries
have choices in these matters; poor ones do not. In poor nations, it is either grow or die.
Applying the Tools: Growth and Terrorism
Most people understand the short-term economic effects of terrorism. Less understood and
analyzed are the long-term effects. Some of these include increasing insurance costs,
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transportation, and security costs, with lower capital expenditures, productivity, and start-ups by
entrepreneurs.
Applying the Tools: The 21st Century: The Age of Technology or One of Many Ages of
Technology?
The conceit of many today is that current technological change is unique. It is not. This box
mentions five prior technological eras: (1) the late 1700s’ steam power and iron manufacturing;
(2) the mid-1800s’ railroads, (3) the late 1800s’ and early 1900s’ chemicals, telephone, telegraph,
electricity, and automobiles, (4) the mid- to late-1900s’ electronics, oil, air transport, computers,
and nuclear power, and (5) the very late 1900s’ genetic engineering, biotechnology, and
telecommunications.
Beyond the Tools: Demand, Keynesian Economics, and Growth
This chapter deals with the supply-side sources of growth rather than the demand side. While the
Keynesians who argue this point of view admit that supply-side sources of growth is only a shortrun phenomenon, they take care of the long-run aspects of growth by asserting that the long run is
really a series of short-runs linked together.
LECTURE OUTLINE: A Map of the Chapter
I. General observations about growth.
A. Growth increases the economy’s potential output.
1. Growth is an increase in the amount of goods and services an economy produces
(Chapter Objective 1a).
2. The study of growth is the study of why that increase comes about assuming that both
labor and capital are fully employed.
3. Growth is an increase in potential output. When an economy is at its potential output, it
is operating on its production possibility curve.
4. Long-run growth focuses on supply; it assumes Say’s Law -- demand is sufficient to buy
whatever is supplied.
5. In the short run, economists consider potential output fixed. They focus on how to get
the economy operating at its potential if, for some reason, it is not.
B. Growth is important for living standards (Chapter Objective 1b).
1. Long-term growth rates matter a lot because of compounding.
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Chapter 24 (8): Growth, Productivity, and the Wealth of Nations
2. This means that growth is based not only on original levels of income in a country, but
also on the accumulation of previous years’ increases in income.
3. A quick way of determining in how many years a nation’s growth rate will cause a
doubling of income, divide 72 by the rate of growth. This is called the Rule of 72.
C. Markets and specialization lead to growth.
1. Economic growth took off when markets began (early 1800s), and as they expanded,
growth accelerated.
2. Adam Smith argued that markets allowed for specialization – the concentration of
individuals on certain aspects of production, and on division of labor – the splitting up
of a task to allow for specialization of production. These lead to increased productivity
– output per unit of input.
3. With increasing specialization and division of labor comes increasing productivity
which creates a higher standard of living for everyone. See Figure 24-1.
4. This argument is reinforced by the principle of comparative advantage. By
concentrating on the production of those goods for which a person’s skills and other
resources are suited, and then trading for those goods for which one does not have a
comparative advantage, the possibilities of production rise.
D. Economic growth, distribution, and markets.
1. Markets are often seen to be unfair because of the effect they may have on the
distribution of income.
2. Markets may not provide equality of income but they do make the poor better off.
Would the poor be better off without markets?
3. Historically, judged from an absolute standard, there is strong evidence that the poor
benefit enormously from the growth that markets foster.
4. Judged from a relative standard, it is not at all clear that markets require the large
differentials in pay that has accompanied growth in market economies.
E. Per capita growth.
1. Per capita output is total output divided by total population.
2. Per capita growth means producing more goods and services per person.
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3. The problem in many developing nations is that although GDP is rising, the population
is rising even faster resulting in a lower per capita growth rate.
4. Per capita growth = percent change in output – percent change in population.
5. Some economists have argued that per capita (mean) output is not what we should be
focusing on. Instead we should focus on median income.
a. Median income is a better measure because it takes into account how income is
distributed.
b. If the growth in income goes to a small majority of individuals who receive the
majority of income, the mean will rise but the median will not.
c. Unfortunately, statistics on median are generally not collected so economists use per
capita income.
d. Whether looking at per capita or median income, growth provides more goods and
services for the public, allowing society to sidestep the more difficult issue of how to
distribute that production.
II. The sources of growth. Economists have five important sources of growth: (1) capital
accumulation – investment in productive capacity, (2) available resources, (3) institutions with
incentives compatible with growth, (4) technological development, and (5) entrepreneurship
(Chapter Objective 2).
A. Investment and accumulated capital.
1. Years ago it was thought that physical capital and investment were the keys to growth.
The flow of investment lead to the growth of the stock of capital.
2. The growth recipe is far more complicated.
a. Capital accumulation does not necessarily lead to growth. Take the former Soviet
Union, for example.
b. Products change, and useful buildings and machines in one time period may be
useless in another.
c. Capital includes much more than buildings and machines.
(1) It includes human capital – the skills that are embodied in workers through
experience, education, on-the-job training, and
(2) Social capital – the habitual way of doing things that guides people in how they
approach production.
d. All economists agree that the right kind of investment at the right time is a central
element of growth.
B. Available resources.
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1. For an economy to grow it will need resources. What constitutes a resource at one time
may not be a resource at another time. Technology plays an enormous role here.
2. Greater participation in the market is another way by which available resources are
increased.
C. Institutions with incentives compatible with growth.
1. Growth-compatible institutions must have incentives built into them that lead people to
put forth effort, and that discourage people from loafing while encouraging others to
loaf.
2. When individuals get much of the gains of growth themselves, they work harder.
3. Markets that feature private ownership of property foster economic growth.
4. Mercantilist economies that feature bribes inhibit economic growth.
D. Technological development.
1. A larger aspect of growth involves changes in technology – changes in the goods and
services we buy, and the way we create goods and services. Technological advances
shift the production possibility curve out by making workers more productive.
2. Technological changes do more than cause economic growth. They change the entire
social and political dimensions of society.
3. As in other things, there are tradeoffs when new technology is introduced.
E. Entrepreneurship is the ability to get things done.
1. That ability involves creativity, vision, and a talent for translating that vision into
reality.
2. Entrepreneurs have been central to growth in the U.S.
F. Turning the sources of growth into growth.
1. In order to be effective, the five sources of growth must be mixed in the right
proportions.
2. It is the combination of investing in machines, people, and technological change that
plays a central role in the growth of any economy.
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III. The production function and theories of growth.
A. Economists’ theories of growth have emphasized the production function – an
abstraction that shows the relationship between the quantity of inputs used in production
and the quantity of output resulting from production.
Output = A ● f(Labor, Capital, Land)
1. This production function has land, labor, and capital as factors of production, and an
adjustment factor, “A”, to capture the effect of technology.
a. “A” is outside the production function since it can effect the production of all factors.
b. The production function emphasizes the same issues as the sources of growth.
(1) Entrepreneurship is captured by labor,
(2) Land by available resources,
(3) Capital by capital accumulation, and
(4) Technology and the production function by institutions and technological
development.
2. In talking about production functions, economists use a couple of terms:
a. Scale economies describe what happens when all inputs increase equally.
(1) Constant returns to scale means that output will rise by the same proportionate
increase in all inputs.
(2) Increasing returns to scale occurs if output rises by a greater proportionate
increase as all inputs.
(3) Decreasing returns to scale occurs if output rises by a smaller proportionate
increase as all inputs (Chapter Objective 3b).
B. The second term describes what happens when one or more input is added without
increasing any other inputs. The law of diminishing marginal productivity states that
increasing one output, keeping all others constant, will lead to smaller and smaller gains in
output (Chapter Objective 3a).
C. The production function, the production possibility curve, and the potential output.
1. When the economy is producing the output determined by the production function, it is
on the frontier of its production possibility curve.
2. By the same token, when the economy is on its production possibility curve, it is
operating at its potential output.
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3. Potential output is the highest amount of output an economy can produce from the
existing production function and the existing resources.
D. The standard theory of growth – the Classical growth model – focuses on capital
accumulation (Chapter Objective 4a).
1. Since investment leads to the increase in capital, they focused their analysis and their
policy advice, on how to increase investment. The linkage was as follows:
savings → investment → increases in capital → growth
2. The Classical growth model focuses on diminishing marginal productivity of labor. See
Figure 24-2.
a. When farming was the major activity in the economy, Parson Thomas Robert
Malthus, an early economist, emphasized the limitation land placed on growth.
b. Since land was fixed, he predicted that as population grew, diminishing marginal
productivity would set in.
c. The linkage was: economic surplus → population increases → output increases →
lower per capita income → too many people → starvation.
d. This belief, called the iron law of wages, combined with the diminished marginal
productivity, led to the belief that in the long run there would be no surplus and
therefore no growth. The long run was called the stationary state.
3. The Classical growth model focuses on diminishing marginal productivity of capital.
a. The Malthusians were dead wrong. Increases in technology and capital overwhelmed
the law of diminishing marginal productivity.
b. The focus turned to the marginal productivity of capital, not labor.
c. The linkage was: capital grows faster than labor → capital is less productive →
slower economic output → per capita growth stagnates → per capita income stops
rising.
d. The classicals also had a story about growth rates among nations. Poor countries
with little capital should grow faster than countries with lots of capital because
diminishing marginal productivity would be stronger for richer nations than for poor
ones. Eventually per capita incomes among nations would converge.
e. This has not happened either, owing to the ambiguity in the definition of inputs
and/or technological progress.
4. The definition of the factors of production is ambiguous.
a. It would seem that the definition of labor would be straightforward – the hours of
work that go into production.
b. But what of the difference between educated workers and workers less educated? To
answer this, economists separate labor into two components.
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(1) Standard labor – the actual number of hours worked.
(2) Human capital – the skills embedded in workers through experience, education,
and on-the-job training.
c. If skills are increasing faster in a rich country than in a poor one, incomes would not
be expected to converge.
5. Economists have estimates of the contribution of the factors to growth.
a. Figure 24-3 estimates factor contribution to growth to be:
FACTOR
Human capital
Physical capital
Quantity of labor
Technology
PERCENT
CONTRIBUTION
13
19
33
35
b. Granted, these estimates are rough. However, it is clear that technology plays a
major role in economic growth.
E. New growth theories focus on technology rather than capital in the growth process.
1. Technology is the result of investment in creating technology.
a. Investment in technology, called research and development, increases the capital
stock of an economy.
b. Growth theory separates investment in capital and investment in technology (Chapter
Objective 4b). Why?
(1) Increases in technology are not as directly linked to investment as is capital.
(2) Increases in technology often have enormous positive spillover effects.
Technological advances in one sector of the economy lead to advances in
completely different sectors.
c. Technological advances have positive externalities – positive effects on others not
taken into account by the decision maker.
d. Some basic research is protected by patents – legal ownership of a technological
innovation that gives the owner of the patent sole rights to its use and distribution for
a limited time.
e. Once people have seen the new technology, they figure out sufficiently different way
to achieving the same end to avoid the patent.
2. Learning by doing also leads to growth.
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a. New growth theory also highlights learning by doing – improving the methods of
production through experience.
b. If positive externalities flowing from learning by doing and new technologies
overwhelm diminishing marginal productivity, we can begin calling ourselves the
“optimistic science,” not the “dismal science.” See Figure 24-4.
3. Technological lock-in is an example of how sometimes the economy does not use the
best technology available.
a. When old technologies become entrenched in the market, or locked into new
products despite the fact that more efficient technologies are available, this is known
as technological lock-in.
b. The best example is the QWERTY keyboard. Others include beta format videos,
Windows operating systems, and English measurement systems.
c. One reason for technological lock-in is network externalities – an externality in
which the use of a good by one individual makes that technology more valuable to
other people. Switching from a technology exhibiting network externalities to a
superior technology is expensive and sometimes nearly impossible. The Windows
operating system exhibits network externalities.
IV. Six economic policies to encourage per capita growth (Chapter Objective 6).
A. Policies to encourage saving and investment.
1. Modern growth theories have downplayed the importance of capital in the growth
process. All, however, agree that it is important. Policymakers are eager to encourage
both saving and investment.
a. The U.S. has used tax incentives for saving.
(1) These include IRAs, or investment retirement accounts, and 401(k) plans, another
form of investment retirement accounts.
(2) Some economists have proposed switching from an income tax to a consumption
tax which taxes individuals only when they consume, thereby exempting all
saving from taxation.
b. In poor countries the poor have subsistence income while the rich in those countries
place their savings abroad for fear of confiscation by government.
2. The borrowing circle of Grameen bank is an example of how to increase investment in a
developing nation.
a. The traditional way of lending money is to ask for collateral. In Bangladesh,
potential borrowers had no collateral.
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b. The bank officer replaced collateral with the micro credit concept—a credit system
that replaces traditional collateral with guarantees by friends of the borrower. In case
of a default, the friends had to make the loan good.
3. Foreign investment provides another source of saving.
a. Developing nations can borrow from the IMF, the World Bank, or from private
sources.
b. None of these are perfect solutions since they come with large strings attached.
B. Policies to control population growth.
1. Developing nations whose populations are rapidly growing have difficulty providing
enough capital and education for everyone. Thus, capital income is low.
2. Policies that reduce population growth include:
a. Free family–planning services.
b. Increasing the availability of contraceptives.
c. Harsh mandatory one-child-per-family policies such as China adopted in 1980.
3. Some economists argue that to reduce population growth, a nation must grow first. As
income and work opportunities, especially for women, rise, the opportunity cost of
having children rises and families will choose to have fewer children.
C. Policies to increase the level of education.
1. In developing nations, the return on investments in education is much higher than in
developed nations.
a. In the U.S., it is estimated that an additional year of school increases a worker’s
wages by an average of 10 percent.
b. An additional year of school in developing nations will increase income by 15-20
percent.
2. For economic development, it is better that the schooling be in practical subjects, not in
the classical curriculum (literature, Greek, Latin).
D. Policies to create institutions that encourage technological innovation.
1. While all agree that that technology is important, no one is sure what the best
technological growth policies are.
2. Not only is research uncertain, so is its application.
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3. Creating patents and protecting property rights are two ways to encourage innovation;
however:
a. Patents are not costless to society.
b. Patents create incentives to innovators who charge high prices for their use.
4. Developing countries face difficult issues with patents.
a. Should poor nations enforce U.S. patent law?
b. Societies must find a middle ground between giving individuals appropriate
incentives to create new technologies that will make them rich and allowing
everyone to take advantage of the benefits of technology.
c. This problem is especially acute when the patents involve life-saving drugs.
5. The corporation and financial institutions encourage innovation.
a. The corporation was invented to limit liability to its owners. Corporations bring
technological innovations to markets. These innovations are often enormously
expensive.
b. Well-developed financial institutions such as stock markets create liquidity and
encourage investment.
E. Provide funding for basic research.
1. Individual firms have little incentive to do basic research because of technology’s
“common knowledge” aspect.
2. This is where the government steps in. The U.S. government provides 60 percent of the
basic research in the country.
3. Much of the funding is channeled through universities.
F. Policies to increase the economy’s openness to trade.
1. In order to specialize, you need a large market.
2. Large markets allow firms to take advantage of economies of scale.
3. The effect of markets on growth is an important reason why economists support policies
that keep domestic markets as regulation free as possible and support international trade.
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CHAPTER SUPPLEMENTS: Other Classroom Aids to Use
 Classic Readings in Economics: "The Theory of Population," pp. 196-197. Parson Thomas
Robert Malthus' famous 1803 essay, in which he argues that population growth will outstrip
food supply thereby leading to mass starvation. This gave rise to the popular labeling of
economics as "the dismal science."
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Chapter 24 (8): Growth, Productivity, and the Wealth of Nations
POP QUIZ
NAME: __________________________________
COURSE: ________________________________
1. In the short run, economists consider potential output:
a. changeable.
b. fixed.
c. impossible to change if the nation is a poor one.
d. impossible to change if the nation is a rich one.
2. If a nation’s GDP is growing at an average rate of 6 percent, about how long will it take for it
to double?
a. 12 years.
b. 8 years.
c. 16 years.
d. Cannot be calculated with the information given.
3. Regarding the growth of markets:
a. everyone benefits equally.
b. judged by an absolute standard, the poor benefit enormously.
c. judged by a relative standard, the poor benefit enormously.
d. markets require the large differentials in pay that ensue.
4. To calculate per capita growth:
a. subtract percent change in output from percent change in population.
b. divide percent change in population by percent change in output.
c. subtract percent change in population from the percent change in population.
d. multiply percent change in output by percent change in population.
5. According to the Classical growth model, in years past the most important source of growth
was thought to be:
a. entrepreneurship.
b. technological development.
c. available resources such as oil and arable land.
d. capital accumulation.
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6. The three types of capital are:
a. physical capital, cultural capital, and human capital.
b. physical capital, social capital, and human capital.
c. cultural capital, social capital, and human capital.
d. physical capital, social capital, and cultural capital.
7. The production function used in this chapter is:
a. output = A (an adjustment factor to capture the effect of technology) – f
(labor,capital,land).
b. output = A (an adjustment factor to capture the effect of technology) / f (labor,capital,land).
c. output = A (an adjustment factor to capture the effect of technology) X f
(labor,capital,land).
d. output = A (an adjustment factor to capture the effect of technology) + f.
(labor,capital,land)
8. The classical growth model featured the following linkage:
a. saving → investment → increase in capital → growth.
b. technology → investment → increase in capital → growth.
c. entrepreneurship → investment → increase in capital → growth.
d. resources → investment → increase in capital → growth.
9. According to Edward Denison, which contributes the most to growth in the U.S.?
a. Human capital.
b. Physical capital.
c. Quantity of labor.
d. Technology.
10 Technological lock-in:
a. is the same thing as learning by doing.
b. fosters economic growth.
c. impedes economic growth.
d. fosters technological change.
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ANSWERS TO POP QUIZ
1. b 2. a 3. b 4. c 5. d 6. b 7. c 8. a 9. d 10. c
CASE STUDIES: Real-World Cases of Textbook Concepts
Case Study 24-1: Freedom and Growth
The Heritage Foundation together with The Wall Street Journal, have compiled an annual Index
of Economic Freedom in order to track international progress toward freer market economies.
In doing so, they evaluated ten key areas:
1.
2.
3.
4.
5.
Trade policy.
Fiscal burden.
Government intervention.
Monetary policy.
Foreign investment.
6.
7.
8.
9.
10.
Banking/finance policy.
Wage and price controls.
Property rights.
Regulation.
Black-market activity.
In each of the ten broad categories, they used 50 independent economic criteria to develop a
snapshot of the level of economic freedom in each country. They presented the data in separate
chapters on each of 155 economies, in which the reader, say, can find the corporate tax rate in
Thailand, the size of the black market in Brazil, or how interest rates are set in Poland.
The evidence they amassed demonstrates that nations with the highest level of economic freedom
also have the highest living standards. Similarly, nations with the lowest levels of economic
freedom also have the lowest living standards. Although the index did not measure political
freedom, the writers postulated that there is a crucial link between it and economic freedom.
(One obvious exception is Singapore.) It is no accident that the world's biggest offenders of
human rights show up near the bottom of the Index of Economic Freedom.
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INDEX OF ECONOMIC FREEDOM
2003 Rankings (Selected Nations)
Category
Ranking
Nation
1
Hong Kong
2
Singapore
Free
3
New Zealand
6
U.S.
9
U.K.
18
Canada
19
Germany
Mostly Free
29
Italy
35
Japan
40
France
72
Brazil
104
Egypt
Mostly Unfree
118
Ecuador
127
China
135
Russia
146
Iran
151
Libya
Repressed
153
Laos
155
Cuba
156
North Korea
A comparison of the scores from the first to this, the 9th edition, demonstrates that wealthy
nations tend to reintroduce restrictions on economic freedom over time. As they become rich,
nations begin adding extensive welfare and other social programs that were not affordable when
they were poorer. Protecting the people whom rapid economic growth has left behind is
important, but in Europe, it has been carried to levels that impede growth and depress living
standards.
The latest edition of economic freedom shows that more nations expanded economic freedom
during 2003 than curtailed it. “If this trend continues, the world-wide growth in economic
freedom will be measured by the increase in prosperity of more and more of the world’s people.
In future centuries, people may come to marvel over the concept of ‘poverty’ and how some
governments relegated their citizens to that awful state when they might instead have lifted them
into prosperity.”
Sources: Mary Anastasia O’Grady, “Liberty = Prosperity,” The Wall Street Journal, November
12, 2002, p. A20, and “The Index of Economic Freedom,” The Heritage Foundation and The
Wall Street Journal, 2002: see: http://cf.heritage.org/index/indexoffreedom.cfm.
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Questions:
1. To which growth model do you think these researchers subscribe?
2. Does economic freedom absolutely require political freedom as well?
3. Can you think of any other categories the researchers could have used?
4. Why didn’t they use growth in GDP to indicate economic freedom?
5. Do you think these researchers are biased? If so, how?
Case Study 24-2: The Starvation Lobby
Are we going to starve ourselves to death because of overpopulation?
The brothers William and Paul Paddock thought so. In 1967, they wrote a book entitled: Famine
1975! America’s Decision: Who Will Survive? "Dr. Doom," Paul Ehrlich, thought so too. In his
1968 book, The Population Bomb, he warned: "The battle to feed all of humanity is over. In the
1970s the world will undergo famines -- hundreds of millions of people are going to starve to
death."
"Dr. Boom," Julian Simon, answered: "A reasonable, prudent answer to the ... question is: With
presently available technology, humanity can feed an ever-growing population, with ever-better
nutrition, for centuries."
Happily, the Paddocks’ and Ehrlich's predictions did not come true. According to Simon, people
around the world were increasingly better fed, and are living longer and healthier lives. There
has been an unmistakable increase in world food production per capita.
The greatest starvation disasters -- the deaths of seven million Ukrainians and other Soviet
citizens in the early 1930s and the 30 million Chinese between 1958 and 1961 -- were caused by
deliberate government policies. In the first instance, Stalin purposefully murdered his own
people, and in the second, Chinese leadership practiced tragically wrong-headed policies.
The market price of wheat adjusted for inflation has fallen over the past two centuries despite an
exploding world population and rising incomes. The price of wheat relative to wages in the U.S.
has fallen to about 1/20th of its level two centuries ago.
Continuing progress is visible in the substantial height increase of Europeans from the late 18th
century to the present. Perhaps more dramatically, in just the past half century, the average
height of Japanese males increased from about 4 feet 7 inches to 5 feet 5 inches. The age of first
menstruation, an indicator of nutrition, has fallen to just about 13 years from more than 16 in
Western Europe since the latter part of the 1800s.
While food production soared, those employed in agriculture steadily declined. Productivity per
worker and per acre has increased thanks to mechanization and biological innovations. We have
increasingly better transportation systems to get food to market. The world is also experiencing
expanded economic freedom. Socialized agriculture has been disastrous no matter where or
when it has been tried.
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Columbus Day 1999 was designated the “Day of Six Billion” by the United Nations. Instead of
rejoicing, UN technocrats wrung their hands, donned their sackcloth and ashes, and wailed that
the largely white economically-advanced nations should kick in more money to their brown-,
black-, and yellow-skinned brothers since their babies affect the advanced nations’ future. The
additional money to be administered by – guess who?
If a pig is born in China, its government counts it as an increase in per capita GDP (benefits
outweighing costs). If a baby is born there, their government, in addition to the UN, count it as a
decrease in GDP – a liability. But is it? If so, why is the per capita GDP of China increasing?
The answer is simple: babies (and later, adults) can provide more benefits to an economy than
costs. Indeed, the governments of Italy, Japan, and Ireland are nervously thinking up ways,
without being sneered and laughed at, of encouraging their people to have more babies.
Source: Julian L. Simon, "What the Starvation Lobby Eschews," The Wall Street Journal,
November 18, 1996, p. A12; Stephen Mosher, “Too Many People? Not By a Long Shot,” The
Wall Street Journal, February 10, 1997, p. A18; Nicholas Eberstadt, “Six Billion Reasons to
Cheer,” The Wall Street Journal, October 12, 1999, p. A26; Robert Rector, “Today’s Special:
Another ‘Hunger Crisis,’ ”, Press Room Commentary, Heritage Foundation, November 11,
2000, see www.heritage.org.; and Mark Elsis, The Three Top Sins of the Universe, October 10,
2002, see http://www.starvation.net.
Questions:
1. Do you see any connection between this case study and the previous one? Explain.
2. Do you agree that more babies are a blessing and not a curse? Explain.
3. What if the bureaucrat’s prayers are answered and populations begin to drop. Economically,
what would likely happen?
4. Will earth ever run out of oil, coal, or copper? Why or why not?
5. Parson Malthus’ thesis is perfectly logical. But is there anything wrong with logic?
Consider, for example: “All Republicans lie, George W. Bush is a Republican; therefore,
George W. Bush lies.” Logical? Perfectly. Empirically verifiable? I don’t think so.
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