Econ 2203 1st Edition Lecture 10 Current LectureEquationsExamplesDefinitionsImportant InformationOutline• Public Policy for Economic GrowthEconomic Growth and Public PolicyHow can public policy do to raise productivity and living standards? – Physical Capital per Worker (K/L)• Policies attract Saving and Investment • Policies attract Investment from Abroad  – Human Capital per Worker (H/L)• Policies encourage Education• Policies benefit the Health of the population  – Technological Knowledge (A)• Policies promote Trade Freely• Policies encourage Research and Development  – Natural Resources per Worker (N/L) • Policies promote Trade Freely ( – Other polices related to Population Growth (L), Property Rights and Political Stability (Saving and InvestmentSaving rate = saving/income30%These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.Domestic Households ($100 income) – 70%Bank: $30Consumption: $70Bank ($30)  Domestic FirmsDomestic firms ($30)  Investment “purchasing capitals”Saving and Investment- Government policies aimed at increasing a country’s saving rate can increase investmenton capital goods (K) and productivity and, thereby, long-term economic growth and living standard – Saving rate: the percentage GDP devoted to saving rather than consumption – Savings = Investment (spending by firms on capitals) • Why not save all the money?– A trade-off between current and future consumption • More saving, less consumption today (income is fixed)• More saving, more investment today• More investment, more goods and services produced• More consumption tomorrowDiminishing Returns and the Catch-Up Effect• If saving rate remains high, does the growth rate of GDP stay high indefinitely or only for a period of time? Diminishing returns to capital: - As the stock of capital K rises, the extra output produced from an additional unit of capital K falls • In the long run, the higher saving rate leads to a higher level of productivity and income but not to higher growth in these variables. Diminishing Returns:- If workers already have a lot of K, giving them more increases productivity fairly little.- If workershave little K, giving them more increases their productivity a lot.-The catch-up effect: The property whereby poor countries tend to grow more rapidly than rich ones- Rich country’s growth- Poor country’s growthInvestment from Abroad• Government can encourage investment abroad to raise domestic capital per person and hence productivity, economic growth and living standards. Two forms: – Foreign direct investment: o A capital investment that is owned & operated by a foreign entity (e.g. A German firm opens a factory in South Carolina) – Foreign portfolio investment:o A capital investment financed with foreign money but operated by domestic residents (e.g. A Japanese buys stock in a U.S. Corporation)Investment from Abroad• Especially benefit poor countries – They cannot generate enough saving to fund investment projects themselves. – They can learn state-of-the-art technologies developed in other countries. • Some of the profits from these investments flow back to the foreign countries that supplied the funds. Education• Education is an investment in human capital (H)• Government can raise productivity, economic growth, and living standards by providing bettereducation services and to encourage the population to take advantage of them. – Public school, subsidized loan for college – Studies show that each year of schooling raises a worker’s wage by 10% in U.S. • Why not go to school? A trade-off between current and future– Spending a year in school requires sacrificinga year’s wages now to have higherwages later.Benefit:• Externality effects: an educated person’s actions might benefit the whole society.– An educated person might find how to improve the productivity of an economy. This idea benefits the whole societyA Problem facing poor countries:• Brain Draining: the emigration of many of the most highly educated workers to rich countries, where these workers can enjoy a higher standard of living.Health and Nutrition• Health care expenditure is a type of investment in human capital—healthier workers are more productive. • In countries with significant malnourishment, raising workers’ caloric intake raises productivity: ( – Over 1962–95, caloric consumption rose 44% in South Korea, and economic growth was spectacular. ( – Nobel winner Robert Fogel:30% of Great Britain’s growth from 1790–1980 was due to improved nutrition. Free TradeTrade has similar effects as discovering new technologies and natural resource—it improves productivity and living standards. • Inward Oriented policies – Aim to raise living standards by avoiding interaction with other countries • Tariffs, limits on investment from abroad – Failed to create growth • Argentina during the 20th century • Outward Oriented policies– Promote integration with the world economy •The elimination of restrictions on trade or foreign investment – Often succeeded•e.g., South Korea, Singapore after 1960Research and Development• Technological progress is the main reason why living standards rise over the long run • The knowledge is a public good: Ideas can be shared freely, increasing the productivity of many. • Policies to promote technological progress: – Patent laws – Tax incentives or direct support for private sector R&D – Grants for basic research at universitiesProperty Rights and Political Stability• Government policies protecting property rights and promoting political stability are able to raise productivity, economic growth and living standard. • When people fear their capital may be stolen by criminals or confiscated by a corrupt government, there is less investment, including from abroad, and the economy functionsless efficiently. – Result: lower living standardsPopulation Growth• Population growth may affect living standards in 3 different ways:1. Stretching Natural Resources( – 200 years ago, Malthus argued that population growth would strain society’s ability to provide for itself. As a result, living standards would keep falling and mankind was doomed to forever live in poverty. ( – Malthus failed to account for technological progress