7 Economic Growth Theory and Policy Once one starts to think about differences in growth rates across countries it is hard to think about anything else ROBERT E LUCAS 1995 NOBEL PRIZE WINNER IN ECONOMICS Contents Contents The The Three Three Pillars Pillars of of Productivity Productivity Growth Growth Levels Levels Growth Growth Rates Rates and and the the Convergence Convergence Hypothesis Hypothesis Growth Growth Policy Policy Encouraging Encouraging Capital Capital Formation Formation Growth Growth Policy Policy Improving Improving Education Education and and Training Training Copyright 2006 South Western Thomson Learning All rights reserved Contents Contents Growth Growth Policy Policy Spurring Spurring Technological Technological Change Change The The Productivity Productivity Slowdown Slowdown and and Speed Up Speed Up in in the the United United States States Growth Growth in in Developing Developing Countries Countries From From the the Long Run Long Run to to the the Short Run Short Run Copyright 2006 South Western Thomson Learning All rights reserved The The Three Three Pillars Pillars of of Productivity Productivity Growth Growth Capital Capital For For aa given given technology technology and and labor labor force force labor labor productivity productivity will will be be higher higher when when the the capital capital stock stock isis larger larger Copyright 2006 Southwestern Thomson Learning All rights reserved FIGURE FIGURE 1 1 Production Production Functions Functions K3 c Yc Output K2 Yb Ya 0 b a K1 L1 Hours of Labor Input Copyright 2006 South Western Thomson Learning All rights reserved The The Three Three Pillars Pillars of of Productivity Productivity Growth Growth Technology Technology For For given given inputs inputs of of labor labor and and capital capital labor labor productivity productivity will will be be higher higher when when technology technology isis better better Copyright 2006 Southwestern Thomson Learning All rights reserved The The Three Three Pillars Pillars of of Productivity Productivity Growth Growth Labor Labor Quality Quality Education Education and and Training Training Human Human Capital Capital The The amount amount of of skill skill embedded embedded in in the the workforce workforce Measured Measured by by amounts amounts of of education education and and training training For For aa given given capital capital stock stock and and given given technology technology labor labor productivity productivity will will be be higher higher when when the the workforce workforce has has more more education education and and training training Copyright 2006 Southwestern Thomson Learning All rights reserved Levels Levels Growth Growth Rates Rates and and the the Convergence Convergence Hypothesis Hypothesis Rate Rate of of increase increase of of capital capital technology technology and and workforce workforce size size and and quality quality directly directly related related to to rate rate of of productivity productivity growth growth Convergence Convergence hypothesis hypothesis The The productivity productivity growth growth rates rates of of poorer poorer countries countries tend tend to to be be higher higher than than those those of of richer richer countries countries Copyright 2006 Southwestern Thomson Learning All rights reserved Figure Figure 2 2 Productivity Productivity Levels Levels and and Growth Growth Rates Rates Real GDP per Capita Richer country 10 000 Poorer country 2 000 Time Copyright 2006 South Western Thomson Learning All rights reserved TABLE TABLE 1 1 Productivity Productivity Levels Levels Growth Growth in in Selected Selected Countries Countries Copyright 2006 South Western Thomson Learning All rights reserved Growth Growth Policy Policy Encouraging Encouraging Capital Capital Formation Formation Capital Capital Formation Formation Forming Forming new new capital capital Synonymous Synonymous with with investment investment Investment Investment The The flow flow of of resources resources into into the the production production of of new new capital capital Copyright 2006 Southwestern Thomson Learning All rights reserved Growth Growth Policy Policy Encouraging Encouraging Capital Capital Formation Formation Investment Investment isis encouraged encouraged by by Lower Lower interest interest rates rates Changes Changes to to tax tax laws laws Technological Technological advances advances Higher Higher demand demand Greater Greater political political stability stability and and respect respect for for property property rights rights Copyright 2006 Southwestern Thomson Learning All rights reserved Growth Growth Policy Policy Improving Improving Education Education and and Training Training More educated More educated better trained better trained workers workers are are more more productive productive and and earn earn higher higher wages wages Education Education and and training training enhance enhance productivity productivity Copyright 2006 Southwestern Thomson Learning All rights reserved FIGURE FIGURE 4 4 Wage Wage Premium Premium for for College College Graduates Graduates Percentage Wage Advantage Females 40 Males 30 20 1973 1975 1980 1985 Year 1990 1995 2004 Copyright 2006 South Western Thomson Learning All rights reserved Growth Growth Policy Policy Spurring Spurring Technological Technological Change Change Technological Technological advance advance spurred spurred by by More More education education More More capital capital formation formation Research Research and and development development Copyright 2006 Southwestern Thomson Learning All rights reserved The The Productivity Productivity Slowdown Slowdown and and Speed Up Speed Up in in the the U S U S The The Productivity Productivity Slowdown Slowdown 1973 1995 1973 1995 Growth Growth rate rate of of productivity productivity declined declined sharply sharply from from the the early early 1970s 1970s through through the the mid mid 1990s 1990s Copyright 2006 Southwestern Thomson Learning All rights reserved The The Productivity Productivity Slowdown Slowdown and and Speed Up Speed Up in in the the U S U S Explanations Explanations include include Lagging Lagging investment investment BUT BUTstatistics statistics show show that that investment investment as as aa percentage percentage of ofGDP GDPstayed stayedconstant constant during during this this period period High High Energy Energy Prices Prices BUT BUTenergy energy prices prices fell