GROWTH AND INSTITUTIONS SUMMARY OF THE
IMPORTANT PARTS + QUIZZES
WEEK 1
We looked at the proximate determinants of growth in the first few weeks and the we dived
into the deep determinants of growth.
This is a macroeconomic course in which we try to answer why some countries are rich
while others are poor.
Robert Solow helped explain economic growth by looking at technological progress and
the accumulation of capital as driving forces.
By 1980 there were new insights into imperfect competition Paul Romer and Robert
Lucas showed the ideas of human capital and the impact of it on growth.
First, we look at the facts in this lecture and then we will provide economic theories that
help us understand the facts. We want to obtain a general framework to understand the
process of growth and development.
GDP as a summary statistic
When we compare countries with one another, we compare per capita income levels. This is
better than using life expectancies or infant mortality, because per capita income is a
useful “summary statistic” of the level of economic development in the sense that it is
highly correlated with other measures of quality of life.
Comparing income levels
When we compare income per capita levels between countries or over time, we need
to make some adjustments to income per capita levels. GDP needs prices for
interpretation for comparisons over time or across countries. We have 4 options:
- Use GDPpc in current prices
- Use GDPpc in constant prices
- Use GDPpc PPP in current prices
- Use GDPpc PPP in constant prices
Constant prices take inflation into account and because these are constant, we can use
them to compare income levels over time.
When we want to compare across countries, we need to convert it to the same currency,
but they can be very volatile (so which one is right?). Therefore, economists prefer to make
international comparisons of GDP: measure actual value of a currency in terms of its
ability to purchase similar products —> conversion factor is called PPP.
Therefore, when we want to compare:
- Average income across countries use GDPpc PPP in current prices.
- Average income of a country over time use GDPpc in constant prices.
- Average income across countries over time use GDPpc PPP in constant prices.
Facts to be explained:
Fact 1: Enormous variation in per capita income across variation (differences across
countries)
- Table: still massive differences even though technology is increasing and the world is
more connected.
- Graph 1: negative correlation, doesn’t have to be causation. Y-axis = look at left tail,
x-axis = look at mean.
, - Graph 2: consumption, not from government and only domestic consumption.
Positive correlation. Consumption is part of GDPpc.
- Graph 3: positive correlation in the long run.
GDPpc vs GDPpworker
Per capita GDP (divide by whole population) is more general than per worker to
compare welfare levels, because it tells us how much output per person is available to be
consumed, invested, or put to some other use. GDP per workers tells us more about the
productivity of the labor force (productivity measure). GDP per worker could be used for
welfare comparisons: Persons not officially counted as being in the labor force may be
engaged in “home production” or may work in the underground economy. Neither of these
activities is included in GDP, and in this case measured output divided by measured labor
input (only divided by working population) may prove more accurate for making welfare
comparisons.
Throughout the book, they use these concepts interchangeably. Assumption is that all
individuals are the same (homogeneous) in the model, such that all individuals work.
Assumption GDPpc = GDP per worker.
Some limitations on using GDPpc
Other dimensions matter as well (environmental quality, life expectancy). GDP can be
adjusted by how ‘clean’ a country produced (adjust it by environmental degradation)
account for externalities.
Also, growth produces winners and losers, but mostly we look at the average, since on
average a country is most of the time better off. However, the country might still pursue
redistributive policies.
When GDPpc increases, it doesn’t mean that people become happier automatically
Easterlin paradox: at a point in time happiness varies directly with income both among and
within nations, but over time happiness does not trend upward as income continues to grow.
Facts to be explained:
Fact 2: Growth rates vary substantially across countries (diverse growth experiences:
differences across countries and time)
- Interpretation of growth rates: a country growing g percent per year will double its per
capita income every 70/g years Let y(t) be per capita income at time t and let y0
be some initial value of per capita income. Then y(t) = y0egt. The time it takes per
capita income to double is given by the time t* at which y(t) = 2y0. Therefore,
y = y0egt* *
2 0 t =log 2/g
The rule of thumb is established by noting that log 2 = 0.7.
- From the Industrial Revolution at 1750/1800, the world started to grow. First,
people only used land and labor and after 1800 there was technology and capital as
well. Land and labor cannot make the GDP grow by a lot because we only have 24
hours a day and land has its limitations (degradation).
Fact 3: Growth rates are not generally constant over time (differences within
countries)
, - of the line when we plot time on the x-axis and log GDPpc on the y-
g is the slope
axis.
-
Slope tends to be constant in US and Europe.
Fact 4: Relative position of countries is not immutable: countries can move from
being poor to being rich and vice versa
-
Relative positions change.
- If all countries grew with the same speed, the position of the countries would remain
the same.
- Graph: red is negative correlation (see lecture 5). We have countries that earn 1/16th
of US and have different growth rates (one is rich now) South Korea and C.African
Republic.
- Graph: More inequality in life expectancy compared to 1800 (not 1950!). Line should
be horizontal if we want the same life expectancies across the world.
Stylized facts – Kaldor
These are facts that are applicable for industrialized countries (long-run) although in the
book they only talk about the US.
1. The ratio of capital to output has been stable
o The real rate of return to capital, r, shows no trend upward or downward.
2. Capital per worker has grown at a sustained rate
o (1+2): output per worker has grown at a sustained rate
3. Capital and labor have captured stable shares of national income: wL/Y = 0.7 and rK/Y
= 0.3 (if we have a model with only 2 factors and no economic profits) much debate:
should land also be taken into account?
4. (2+3): Wages have grown at a sustained rate
5. (2+3): The real interest rate, or return to capital, has been stable (nominal interest rate
– inflation = real interest rate shows no trend).
In the book it is slightly different see page 33
The average growth rate of output per person has been positive and relatively
constant over time—that is, the United States exhibits steady, sustained per capita
income growth.
Another fact: Growth in output and growth in the volume of international trade are
closely related.
Another one: Both skilled and unskilled workers tend to migrate from poor to rich
countries or regions.
What we will do in the next few weeks
Give answer to the following questions:
1. Why rich countries are rich and poor countries are poor?
• Proximate determinants of the level of development
2. What is the engine of economic growth?
• Technological progress
3. Why do we observe growth miracles
• Fundamental (deep) determinants of the level of development
, Proximate determinants of growth
- Share of labor and capital. 1/3 goes to capital and 2/3 goes to labor. (Total labor
includes also human capital).
- GDP per worker difference because of more capital per worker (1), differences in
productivity (2). In reality it’s both (3).
Quiz week 1:
(1) You want to assess welfare differences between the United States and India in
2019. Which of the following measures can you use to perform this comparison
(multiple answers may be correct)?
GDPpc in constant dollar of 2010 (adjusted by PPP)
GDPpc in current dollars (adjusted by PPP)
When performing welfare comparisons across countries, one should covert the GDPpc
into a single measure (same currency) and adjust the measure by Purchasing Power Parity
(PPP); this allows us to compare the Purchasing Power of the “average individual” across
countries.
(2) For the World as a whole, the average yearly growth rate of GDPpc, between 1500
and today, can be characterized in the following way:
The world as a whole has experienced an acceleration of the average growth rate from
about 0% to more than 2%.
(3) The cumulative distribution of the World Population by GDP per worker (relative to
the U.S.) reveals that in 2008:
About 2/3 (approx. 70%) of the world’s population lived in countries with less than 20 % of
US GDP per worker slide 17. About 30% lived in countries with more than 20% of U.S.
GDP per worker.
About 20% of the world’s population lived in countries with less than 20% of U.S. GDP per
worker.
(4) Looking at the evolution of the cumulative distribution of the World population, by
their life expectancy at birth, one can correctly infer that (multiple answers may be
correct):
Between 1800 and 2012 inequality across countries, in terms of life expectancy at birth,
increased.
Between 1950 and 2012 most of the improvement in life expectancy came from countries
with a relatively low life expectancy in 1950.
Between 1800 and 2012 the share of the population that lived in countries with a life
expectancy at birth of at least 40 years increased.
Comparing 1800, 1950 and 2012 the world was the least unequal in terms of life
expectancy at birth in 1950.
In 1800, life expectancy at birth around the globe was no less than 25 years and no more
than 40 years slide 31
