The Wealth of Nations and Economic Growth

CHAPTER

7

DYNAMIC P OWERP OINT™ S LIDES BY S OLINA L INDAHL

The Wealth of Nations and Economic Growth

CHAPTER OUTLINE Key Facts about the Wealth of Nations and Economic Growth Understanding the Wealth of Nations Incentives and Institutions For applications, click here

To Try it! questions

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Food for Thought…. Some good blogs and other sites to get the juices flowing:

SEE THE INVISIBLE HAND

Economic growth is a matter of life and death to the 1.8 million children who die of diarrhea each year globally.

Key Facts about the Wealth of Nations and Economic Growth Fact One: GDP per Capita Today Varies Enormously among Nations

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Hans Rosling debunks myths about the so-called "developing world” with humor, data and visual flair. (19:53 minutes) or shorter talk here (4:48 minutes)

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Key Facts about the Wealth of Nations and Economic Growth

Wealth and Health go Together.

Source: Penn World Tables and World Bank Group, World Development Indicators, 2005 B

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Key Facts about the Wealth of Nations and Economic Growth Fact Two: Everyone Used to be Poor

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Key Facts about the Wealth of Nations and Economic Growth

A Primer on Growth Rates How is economic growth measured?

y t  y t 1 gt   100 y t 1 Where yt is per capita real GDP in year t

Example:

Year

real GDP per capita 2008 2009

g 2009

$15,000 $15,500

15,500  15,000   100  3.33% 15,000 BACK TO

The Rule of 70 (The Magic of Compounding) The rule of 70: 70 Doublingtime  growth rate in % Example: If real GDP per capita is growing at an annual growth rate of 3.5%, it will double in:

70  20 years. 3. 5 The moral? Small improvements in growth add up fast (the power of compounding). BACK TO

Try it! Let's figure out how long it will take for the average Indian to be as wealthy as the average Western European is today. Note that all numbers are adjusting for inflation. India's GDP per capita is $3,000, and let's say that real output per person there grows at 5 percent per year. Using the rule of 70, how many years will it take for India to reach Italy's current level of GDP per capita, about $24,000 per year? a) 42 years b) 14 years c) 28 years. To next d) 12 years Try it!

A Little Growth Goes a Long Way

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Key Facts about the Wealth of Nations and Economic Growth Fact Three: There are Growth Miracles and Growth Disasters

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Try it! Would you rather live in a country that has high taxes and a generous social safety net or a country with low taxes and little social safety? a) High tax, generous social safety b) Low tax, low level of social safety To next Try it!

Understanding the Wealth of Nations

The Factors of Production are important Physical capital: the stock of tools including machines, structures, and equipment. Human capital: is the productive knowledge and skills that workers acquire through education, training and experience. Technological knowledge: knowledge about how the world works that is used to produce goods and services. BACK TO

What Causes Economic Growth?

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Understanding the Wealth of Nations

Why do some nations have faster growth than others? Besides factors of production, incentives and institutions matter.

Institutions = “rules of the game” that structure economic incentives. Institutions of Economic Growth 1. 2. 3. 4. 5.

Property rights Honest government Political stability A dependable legal system Competitive and open markets BACK TO

Korea’s Experiment Before division after WWII: similar Culture, physical capital, technology. North Korea became a communist state with a centrally planned economy. South Korea adopted the capitalist free market model.

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SEE THE INVISIBLE HAND North and South Korea at night

Institutions 1. Property rights: Provide incentives to work hard. Encourage investment and innovation.

Without property rights: Effort is divorced from payment, reducing incentives. Free riders become a problem.

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Institutions Free Rider = someone who consumes a resources without working or contributing to the resource’s upkeep. China’s “Great Leap Forward”- which introduced farming collectives- reduced incentives. 20-40 million starved. 1978, farmers in Xiaogang met in secret to devise a plan to keep some of their produce. (background photo) Productivity improved so quickly the government allowed the experiment to proceed. Food production increased 50% in 5 years 1978-1983. B A CK

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Institutions • No one must “own” you for economic freedom to exist. • Ownership is right to shape, use, and dispose. • You wouldn’t think you really owned it if the government • The government would be the de facto owner. • Ownership is control, without it you don’t “own” it.

• Mongolian Yaks – were owned by the government for decades (the People’s Yaks) • Total Yak population did not change from 1920s to 1990s BACK TO

Institutions – Property Rights • After the collapse of central planning, property rights were assigned.

• The Yak population soared from 25 to 32 million in a few short years • When it’s your yak, not “everybody’s” yak, you take care of the yak and make more yaks • You “share” your Yaks with other people with mutually beneficial trades involving yak products. • “Sharing” when done at gun point (i.e. government confiscation of property) is not the proper term to use.

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Institutions 2. Honest Government Property rights are meaningless unless government guarantees property rights. Corruption bleeds resources away from productive entrepreneurs. Corruption takes resources away from more productive government activity.

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Corruption and Growth Don’t go Together

Source: Penn World Tables and World Bank Group, World Development Indicators, 2005

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Corruption Who’s Who List

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Institutions 3. Political Stability Changing governments without the rule of law creates uncertainty which leads to less investment in physical and human capital. In many nations civil war, military dictatorship, and anarchy have destroyed the institutions necessary for economic growth. Bullet casings from Liberia’s Civil War: Bad soil for anything to grow. BACK TO

Institutions 4. Dependable Legal System

A good legal system facilitates contracts and protects property from others (including government). Poorly protected property rights can result from too much government or too little government. In India, residents who purchase land have to do so more than once because of lack of proper record keeping. BACK TO

Institutions 4. Dependable Legal System

“Rule of Law” – crucial to economic growth The rule of law is the general concept that government as well as the governed are subject to the law and that all are to be equally protected by the law.

Otherwise…..worst kinds of corruption Power does not equal wisdom or good judgment BACK TO

Institutions 4. Dependable Legal System • Most of human history the rules by which life was governed were usually determined by force and fraud • He who had the power made the rules. Absolute monarch or tyrannical despots •

“Divine right of Kings” subjects accepted their rule without question

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Institutions

5. Competitive and Open Markets Encourage the efficient organization of resources. One study found: if India used its physical and human capital as efficiently as the U.S., India would be 4x richer than it is today.

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Try it! India and China come up a lot in this chapter. What fraction of humans live in India and China together? a) Roughly 1/2 of all humans. b) Roughly 1/4 of all humans. c) Roughly 1/3 of all humans. d) Roughly 1/5 of all humans.

To next Try it!

Institutions Why do poor countries use their capital inefficiently? Whether inadvertently or not, inefficient and unnecessary regulations: Create monopolies and impede markets Example: until recently in India, it was illegal to produce shirts using large-scale production

Economies of scale = the advantages of large-scale production that reduce average cost as quantity increases BACK TO

Try it! Think-pair-share: Why do you think expensive red tape is hard to get rid of in many poor countries?

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Institutions and Growth Miracles Revisited

Why did England’s Industrial Revolution bring us:      

large scale factories mass production the steam engine the railroad the beginnings of a consumer society the first sustained rise in human living standards above subsistence?

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Institutions and Growth Miracles Revisited Property rights? England’s geography and Navy helped protect property rights Honest government Growth of Parliament (and religious changes) reduced royal tyranny Political stability Middle class developed from growth A dependable legal system Less corruption as royal and Catholic power is reduced Competitive and open markets England opened itself more to trade BACK TO

Try it!

What is the difference in GDP per person between Nigeria and Argentina? a) The GDP per person in both countries is roughly the same. b) Argentina's GDP per person is about $9,000 > Nigeria's c) Nigeria's GDP per person is about $9,000 > Argentina's d) None of the above BACK TO