MACROECONOMICSAND THE GLOBAL BUSINESS ENVIRONMENT

The Wealth of NationsThe Supply Side

3-2

Key Concepts

Economic Growth Total output (GDP) Growth Importance of Trend Growth Output per capita growth

Elements of Growth Labor Capital Total Factor Productivity

3-3

Economic Growth

Economic Growth: an increase over time in the quantity of goods and services produced by an economy

Rate of economic growth Real GDP: adjusts for inflation Real GDP per capita: adjusts for size of population

Why do we care about economic growth? Affects human welfare A little increase in growth over a long period makes a

huge difference Trend growth more important than business cycle

3-4

The Importance of Economic Growth

U.S. Counterfactual History

$0

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

1789

1797

1805

1813

1821

1829

1837

1845

1853

1861

1869

1877

1885

1893

1901

1909

1917

1925

1933

1941

1949

1957

1965

1973

1981

1989

1997

Per

Capit

a I

nco

me

Actual Real GDP Per Capita 1% Higher Real GDP Per Capita

Business Cycles still occur, but trend is key difference

3-5

The Importance of Economic Growth

Is higher trend growth possible? Thomas Malthus (1798): No

finite resources => limit to both economic and population growth (i.e. more people, less economic growth)

“Malthusian Perspective”

Economist Perspective- “Half a Billion Americans?”(8/22/02 ): Yes More people, more economic growth How do we reconcile different views on growth?

What view does the empirical evidence support?

3-6

The Importance of Economic Growth

3-7

The Evidence

Population Growth and Economic Growth

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000

$40,000

0 1000 1500 1600 1700 1820 1870 1913 1950 1973 1998

Billions

of $

0

1

2

3

4

5

6

7

Billions

of P

eople

World Real GDP Population

3-8

The Evidence

World GDP Per Capita

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

0 1000 1500 1600 1700 1820 1870 1913 1950 1973 1998

3-9

The Evidence

Real GDP Per Capita, 0-1998 AD

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

0 500 1000 1500 1550 1600 1650 1700 1750 1820 1870 1913 1950 1973 1998

Western Europe Eastern Europe Former USSR Total Western OffshootsLatin America Japan Asia Africa

3-10

The Evidence

Economic Growth: China vs. Western Europe

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

$14,000

$16,000

$18,000

$20,000

1000 1150 1300 1400 1500 1820 1913 1950 2001

Per

Capit

a G

DP

China West Europe

3-11

The Evidence

3-12

The Evidence

Real Per Capita GDP

3-13

Evidence does suggest higher trend growth possible for many countries

Evidence also indicates that wide range of growth rates for many countries

Why the difference? Why do some countries take off when others do not?

Again, important question since even a little difference over a long time makes a big impact

The Evidence

3-14

Benefits of Economic Growth

Growing population Sustain more people

Life expectancy Longer lives, more accomplishments

Improved standards of living Higher income levels, afford more leisure

Poverty reduction A function of both inequality and economic growth

Recent emphasis on increasing growth Inequality may not change

3-15

Inequality and Growth

0.20

0.30

0.40

0.50

0.60

0.70

0.80

-10 -5 0 5 10 15 20

Growth Rate

Mor

e In

equa

lity

3-16

2004 Real Per Capita GDP (PPP)

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000

$40,000

$45,000

United States

Japa

nKor

ea

Trinidad

and To

bago

Mex

ico

Braz

il

China

Egyp

t

Pakista

n

Mon

golia

Hait

i

Nepal

3-17

Explaining Differences in GDP per capita

GDP per capita =GDP

Population

GDP Hours Number Employed Labor Force

Hours Number Employed Labor Force Population

Labor ProductivityLabor Productivity

Average Hours WorkedAverage Hours WorkedEmployment RateEmployment Rate Labor Force

Participation Rate

Labor ForceParticipation Rate

3-18

Explaining Differences in GDP per capita (2001)

Country

GDP per Capita ($PPP)

Hourly Productivity

($PPP)

Average Hours Worked

Employment Rate

Participation Rate

U.S. 33869 38.28 1821 0.952 0.51Japan 25480 27.96 1821 0.949 0.53Korea 15226 13.66 2447 0.961 0.47Denmark 28360 37.28 1482 0.957 0.54France 24230 39.27 1532 0.915 0.44Germany 25427 36.67 1467 0.92 0.51Italy 25055 38.29 1606 0.904 0.45Netherlands 27337 40.08 1346 0.976 0.52Norway 30691 43.86 1364 0.964 0.53Sweden 25580 32.65 1603 0.95 0.51U.K. 24819 30.92 1711 0.949 0.49

GDP Hours Number Employed Labor Force

Hours Number Employed Labor Force Population GDP per

capita

•U.S. success more than labor productivity: avg. hours worked, employment rate, & participation rate important

•Two policy implications: focus on factors that (1) boost labor productivity and (2) increase labor market flexibility

•However, only increases in labor productivity can produced sustained increased in GDP per capita

3-19

Role of Inputs

More inputs means more output Diminishing returns

1 worker = $10 in output 2 workers = $18 in output 3 workers = $24 in output

Marginal return is$8 in outputMarginal return is $6 in output

3-20

Analysis of Growth

Capital(buildings,

infrastructure and

machines)

Capital(buildings,

infrastructure and

machines)

Total Factor Productivity

(technological knowledge

and efficiency)

Total Factor Productivity

(technological knowledge

and efficiency)

Output (GDP)Output (GDP)

Labor(Hours worked, number

of workers)

Labor(Hours worked, number

of workers)

3-21

Production Function

Output = TFP Capital Stocka Labor Hours(1-a)

Real GDP

Total Factor Productivity

A parameter (a number, 0 < a < 1)

•Total factor productivity (TFP) measures how effectively the inputs are turned into output•True impact of capital and labor depend on their marginal product:

how much output will the next additional input add to output•diminishing marginal returns: holding other inputs and TFP fixed, the

marginal product of an input increases at a decreasing rate

3-22

Cobb-Douglas example

0

100

200

300

400

500

600

700

800

900

1000

0 500 1000 1500 2000 2500

Rea

l G

DP

Hours worked

TFP = 1Capital = 500a=0.6

3-23

0

100

200

300

400

500

600

700

800

900

1000

0 500 1000 1500 2000 2500

Hours Worked

Rea

l GD

P0.6 0.4(500) (Labor Hours)Output

3-24

0

200

400

600

800

1000

1200

1400

1600

1800

0 500 1000 1500 2000 2500

Capital Stock

Output

0.6 0.4(Capital Stock) (1000)Output

3-25

Implications for labor productivity

Output = TFP Capital Stocka Labor Hours(1-a)

Labor Productivity

aGDP Capital

TFPLabor Hours Labor Hours

Changes in Labor Productivity(1) Total Factor Productivity(2) Capital per Labor Hour

3-26

Implications for Labor Productivity

implies…

% Labor Productivity = % TFP %Capital

aLabor Hour

aGDP Capital

TFPLabor Hours Labor Hours

3-27

Capital Stock per labor hour

Lab

or P

rodu

ctiv

ity

500 1000

8

12

Labor Productivity = TFP (Capital Stock/Labor Hours)a

3-28

Capital Stock per Labor Hour

Labor Productivity

k1

y1

y2

Output/Labor Hour = TFP (Capital/Labor Hour)a

Increase in TFP

3-29

3-30

3-31

Labor Productivity Decomposition

0.19

0.69

0.510.43

0.57

0

0.5

1

1.5

2

2.5

3

1800-1855 1855-1890 1890-1927 1929-1966 1966-1989

Labor Productivity TFP contribution Capital Stock/Labor

U.S. Labor Productivity Decomposition

3-32

Growth in Output

Increase in labor supply May have no impact on GDP per capita Not sustainable Diminishing returns

Increase in capital stock Must increase at faster rate than labor &

depreciation Diminishing returns

Increase in TFP No diminishing returns in this framework

Intensive vs. extensive economic growth More of the same growth vs. more growth with less

resources

3-33

Growth Accounting

Output = TFP Capital Stocka Labor Hours(1-a)

Production Function

Take the logarithms, and then changes in the logarithms%∆ Output = %∆TFP + a x %∆Capital Stock + (1-a) x %∆ Labor Hours

Steps

•Find percent change in capital stock and labor inputs multiplied by their weights

•Find percent change in output

•Difference between two or the residual is the percent change in total factor productivity

3-34

Growth accounting for Japan, Germany, the UK, and the United States, 1913–1950.

3-35

Growth accounting for Japan, Germany, the UK, and the United States, 1950–1973.

3-36

Growth accounting for Japan, Germany, the UK, and the United States, 1973–1992.

3-37

Europe and Asia

  Total Output:

Of Which

    Capital Labor TFP

Golden Age 1950-73        

France 5.0% 1.6% 0.3% 3.1%

UK 3.0% 1.6% 0.2% 1.2%

W. Germany 6.0% 2.2% 0.5% 3.3%

Asian Miracle 1960-94

       

China 6.8% 2.3% 1.9% 2.6%

Hong Kong 7.3% 2.8% 2.1% 2.4%

Indonesia 5.6% 2.9% 1.9% 0.8%

Korea 8.3% 4.3% 2.5% 1.5%

Thailand 7.5% 3.7% 2.0% 1.8%

Singapore 8.5% 4.4% 2.2% 1.5%

Europe relied on capital and TFP – Asian countries have relied on capital

3-38

Growth Accounting

Japan Capital growth important through out Labor, TFP important ’50 – ’73

US TFP important until ’73 Labor important after ’73 thru mid 1990s Productivity strengthens in mid1990s

UK and Germany rely less on labor

3-39

Growth AccountingAsian Tigers, 1966 - 1990

3-40

China vs. India 1993-2004

3-41

Growth accounting in emerging markets, 1960–1994.

3-42

Summary

Importance of Growth Sources of Growth

GDP per capita Hourly productivity Number of hours worked

Productivity Capital Accumulation TFP

Growth Accounting