Growth Capital Accumulation and the Economics of Catching Up vs Cutting Edge Outline The Solow Model and Catch Up Growth The Solow Model Details and Further Lessons Growing on the Cutting Edge The Economics of Ideas The Future of Economic Growth Introduction In 2006 China GDP per capita grew by 10 United States GDP per capita grew by 2 3 United States has never grown as fast as the Chinese economy is growing today Why is China growing more rapidly than the U S Is there something wrong with the U S Do the Chinese have a magical potion for growth Introduction Why is China growing more rapidly than the U S Is there something wrong with the U S economy Do the Chinese have a magical potion for growth Introduction There are two types of growth Catch up growth Takes advantage of ideas technologies or methods of management already in existence Cutting edge growth Primarily about developing new ideas The U S economy is on the cutting edge The Chinese economy is catching up Introduction China is growing much faster than the U S because The U S economy is on the cutting edge The Chinese economy is catching up The Solow Model Total Output Y of an economy depends on Physical capital K Human capital education x Labor eL Ideas A This can be expressed as the following production function Y F A K eL The Solow Model For now let A e and L be constant so that Y F K MPK marginal product of capital The additional output resulting from using an additional unit of capital As more capital is accumulated the MPK gets smaller and smaller Assuming diminishing returns Capital Production and Diminishing Returns Growth in China USA Iron logic of diminishing returns The Chinese economy is able to grow so rapidly It turned toward markets which increased incentives The capital stock was low The MPK was high China will not be able to achieve these high growth rates indefinitely The Solow Model and Catch Up Growth Why Bombing a Country Can Raise Its Growth Rate Also explained by the iron law Much of the capital stock was destroyed during WWII Therefore the MPK was high Following the war both Germany and Japan were able to achieve much higher growth rates than the U S as they caught up The Solow Model and Catch Up Growth Conclusions 1 Catch up growth Germany Japan is much greater than cutting edge growth U S 2 Eventually the catch up growth slows down The Solow Model and Catch Up Growth Capital Growth Equals Investment Minus Depreciation Capital is output that is saved and invested Let g be the fraction of output that is invested in new capital The next figure shows how output is divided between consumption and investment when g 0 3 Output Consumption Investment Depreciation Depreciation amount of capital that wears out each period Depreciation Rate d fraction of capital that wears out each year depreciation d K Or depreciation d K Depreciation Is Capital The Only Key to Growth As capital increases Depreciation increases at a constant rate d Output increases at a diminishing rate Investment is a constant fraction of output At some point depreciation will equal investment The capital stock will stop growing steady state Output will stop growing Investment Depreciation Double Check the Math At K 100 Y 100 10 Depreciation 0 02x100 2 Investment 0 3x10 3 Investment Depreciation Result K and Y grow At K 400 Y 400 20 Depreciation 0 02x400 8 Investment 0 3x20 6 Investment Depreciation Result K and Y decrease At K 225 Y 225 15 Depreciation 0 02x225 4 5 Investment 0 3x15 4 5 Investment Depreciation Result 1 Investment Depreciation 2 K and Y are constant This is a steady state Capital Alone Cannot Be Key to Growth The logic of diminishing returns means that eventually capital and output will cease growing Other factors must be responsible for long run economic growth Human capital knowledge skills experience Technological knowledge better ideas Increasing Human Capital Better Ideas Drive Growth What about Human Capital Like capital it is subject to diminishing returns and it depreciates Logic of diminishing returns also applies to human capital Conclusion Human capital also cannot drive long run economic growth What about technological knowledge Better Ideas Drive Growth Technological knowledge A way of getting more output from the same input increase in productivity We can include technological knowledge in our model by letting A stand for ideas that increase productivity Therefore let the production function for this example be Y A K Better Ideas Drive Growth Better Ideas Drive Growth Conclusion Technological knowledge better ideas are the key to long run economic growth Solow estimated that better ideas are responsible for of our increased standard of living A Deeper Look Let s review what we know now If Investment Depreciation K and Y grow If Investment Depreciation K and Y fall If Investment Depreciation K and Y are constant A Deeper Look Two important results Steady state equilibrium occurs when investment equals depreciation When K is in steady state equilibrium Y is also in steady state equilibrium These results are illustrated in the next two diagrams K in Steady State So is Y K In Steady State so is Y Increase the Investment Rate What happens when g the fraction of output that is saved and invested increases Conclusion an increase in the investment rate increases a country s steady state level of GDP We show this result in the next diagram Increase in Investment Rate Increase in Investment Rate The results presented predict that An increase in investment rate g causes output to increase Because labor is held constant output per capita also increases Testing the model Are its predictions consistent with real world data The next figure suggests that they are Increase in Investment Rate Increase in Investment Rate Conclusions g steady state level of output As the economy moves from the lower to the higher steady state output growth rate of output This higher growth rate is temporary investment rate steady state level of output but not its long run growth rate South Korea The Case of South Korea In 1950 South Korea was poorer than Nigeria 1950s the investment rate was 10 1970s Investment rate more than doubled 1990s Investment rate increased to over 35 South Korea s GDP increased rapidly As GDP reached Western levels the growth rate has slowed Increase in Investment Favorable Incentives and institutions Savings must be efficiently collected and used Soviet Union had a high saving rate but savings were not invested well
View Full Document
Unlocking...