Chapter 25 Flashcards
But before we go on . . . what does it mean to be poor? How do we measure poverty?
• is it by income - “per capita income of less than $5 per day”
• is it relative - “you’re poor if your income is in the lowest 10% of your country.”
• is it by consumption - “you have to spend a high % of your income on necessities.
By income in $$$
• different people have different standards. Consensus seems to have formed around living on <$10 per day.
o Ravillion, M. (2010). The developing world’s bulging (but vulnerable) middle class. World Development 38(4) 445-54.
o Kharas, H., and Gertz, G. (2010). The new global middle class: A cross-over from west to east. Wolfensohn Center for Development.
o Milanovic, B. and Yitzhaki, S. (2002). Decomposing world income distribution: Does the world have a middle class? Review of Income and Wealth 48(2), 155-78.
By relative income
• Consensus is having an income <75% of your country’s median
income.
o Ravillion, M. (2010). The developing world’s bulging (but vulnerable) middle class. World Development 38(4) 445-54.
Alimentary poverty, capability poverty, and patrimony poverty
Alimentary
poverty: can’t afford food
Capability poverty: can’t afford food + health care + education
Patrimony poverty: can’t afford food + health care + education + clothes + housing + transportation
But all this raises the questions:
• why are some countries richer than others?
• why do some countries grow quickly while others seem stuck in poverty?
• what policies may help raise growth rates and long-run living standards?
Labor productivity
• this ability depends on productivity, the average quantity of goods + services produced per unit of labor input.
What does productivity mean?
• standards of living depend on productivity, the average quantity of goods + services produced per unit of labor input.
• ask: how much stuff does each worker make in a work day?
• when a nation’s workers are productive, real GDP is high and so are incomes.
• when productivity grows rapidly, so do living standards.
• so the question is: if productivity is so important, how can we improve it?
What are the many pieces of productivity
• let’s look at a few
• productivity = the average quantity of goods + services produced per unit of labor input.
• how much stuff can each worker make in a day?
• let:
Y = real GDP = quantity of output produced
L = quantity of labor (how many people are
working)
so productivity = Y/L (output per worker)
Physical Capital Per Worker
• recall: physical assets (like equipment and structures) used to produce goods + services is called [physical] capital
- we call it ‘K’.
•K/L = capital per worker -> physical capital / number of workers.
• productivity is higher when the average worker has more and better capital to work with (machines, equipment, etc.).
• this means that as capital per worker increases, so does income.
o an increase in K/L causes an increase in Y/L. o in English -> if physical capital per worker increases, then income per worker should increase also.
o but beware of the law of diminishing marginal product of capital!!!
What does human capital per worker mean
• Human capital (H): the knowledge and skills workers acquire through education, training, and experience.
• H/L = the average worker’s human capital >
human capital / number of workers
• productivity is higher when the average worker has more and better human capital to rely on (education, skills, etc.).
• this means that as human capital per worker increases, so does income.
o an increase in H/L causes an increase in Y/L. o in English -> if human capital per worker increases, then income per worker should increase also
o but beware of the law of diminishing marginal product of capital!!!
Natural Resources Per Worker
• Natural resources (N): the factors of production that nature provides, e.g., land, oil, mineral deposits, good soil.
• other things equal, more N allows a country to produce more Y.
• in per-worker terms, an increase in N/L causes an increase in Y/L.
• Natural resources (N): the factors of production that nature provides, e.g., land, oil, mineral deposits, good soil.
• some countries are rich because they have abundant natural resources
o Saudi Arabia has lots of oil - and not much else.
• but countries doesn’t need much N to be rich o Japan imports the N it needs.
What does Technological Knowledge mean
• Technological knowledge: society’s understanding of the best ways to produce goods + services
o I have sometimes seen this as ‘A’ -> think of this as ‘know how.”
• technological progress is more than a faster computer, a higher-definition TV, or a smaller cell phone.
• it’s any advance in knowledge that boosts productivity (which allows society to get more output from its resources).
o Henry Ford and the assembly line.
How is technological knowledge different from human capital?
• technological knowledge (A) refers to society’s understanding of how to produce goods + services.
• A can be shared among producers -> we call it ‘spillover’ o this is one reason why tech firms cluster together in
Silicon Valley -> to enjoy the spillover effect
• human capital (H) results from a person’s own brain power skills + experience + knowledge
• A is general knowledge about how to do things.
• H is personal to the person who acquires it.
• H goes home at the end of the day. A sticks around and can be used by anyone at the firm. both are important for productivity.
The Production Function
•the production function is a graph or equation showing the
relation between output and inputs: Y = A f(L, K, H, N)
• notice a few things:
• fl) is a mathematical equation (a “function” that shows how inputs combine to produce output
A
o if we know the quantity of inputs (L, H, K, A, N), a production function should predict how much stuff we can make.
The Production Function … notice something?
• the production function is a graph or equation showing the relation
between output and inputs: Y = A fiL, K, H, N)
• notice a few things:
o all the inputs are positively correlated > if LT, Y 1 o fis a multiplicative function -> we need all of these things to
make anything -> if any input = 0, then Y = 0.
• a machine (K) without anyone to work it (L) is useless.
The Production Function
• the production function is a graph or equation showing the
relation between output and inputs: Y = A f{L, K, H, N)
• notice a few things:
o A multiplies the function fl), so improvements in technology (increases in A) allow more output (Y) to be produced from any given combination of inputs
Y = A fL, K, H, N)
• the production function displays constant returns to scale:
Changing all inputs by the same percentage causes output to change by that percentage. For example,
• doubling all inputs (multiplying each by 2) causes output to double:
2Y = A f(2L, 2K, 2H, 2N)
What does the production function exhibit
The Production Function
Y = A fL, K, H, N)
• the production function exhibits constant returns to scale:
Changing all inputs by the same percentage causes output to change by that percentage. For example,
o increasing all inputs 10% (multiplying each by 1.1) causes
output to increase by 10%: 1.1Y = A f1.1L, 1.1K, 1.1H, 1.1N)
NOTE WELL -all the inputs MUST CHANGE BY THE SAME AMOUNT. This does not work if we simply change one variable!.
What does productivity (output per worker) depend on?
• and so productivity (output per worker) depends on:
o the level of technology (A)
o physical capital per worker (K)
o human capital per worker (H)
o natural resources per worker (N)
Diminishing Returns and the Catch-Up Effect
• the government can implement policies that can, for example, raise saving and investment > more on this in the next chapter.
• K will rise, causing productivity and living standards to rise in the long run.
• But this faster growth is temporary, due to diminishing returns to capital (remember this from micro?)
• as Krises, the extra output from an additional unit of K falls.
Education
• government can increase productivity by promoting education - which is really an investment in human capital (H).
o public schools
o subsidized loans for college or the Excelsior Scholarship!
• investing in H also involves a tradeoff between the present &
future
o spending a year in school requires sacrificing a year’s wages now to have higher wages later -> this is the opportunity cost of education.
o the expectation is that education pays off, but not right away. o in fact, for a while, the return on your education will be negative.
Health and Nutrition
• money spent on health care is another type of investment in human capital -> healthier workers are more productive.
• if people in a country are malnourished, raising caloric intake raises productivity:
over 1962-95, caloric consumption rose 44% in S. Korea, and economic growth was spectacular [again, this is not the only reason for this growth, though].
• expenditures for health care is another type of investment in human capital -> healthier workers are more productive.
• in countries with significant malnutrition, raising caloric intake raises productivity:
• Nobel winner Robert Fogel: 30% of Great Britain’s growth from 1790-1980 was due to improved nutrition.
o note that the causation could go the other way -> instead of people getting richer because they are healthier, it could also be that people are healthier because they are richer.
3 possible fundamental causes of economic growth:
-Culture
-Geography
-Institutions
Culture as a fundamental cause
• in modern times - some countries reward innovation (and do not punish failure so much).
• historical view - countries are rich because their people share common experiences and religion.
• example: Protestant religion values hard work, thrift, savings.
• “being rich means being favored by God.”
Geography as a fundamental cause
• climate - a hot climate affects people’s work effort.
- cold or temperate weather allows people to work.
- hot weather makes people listless and passive and not interested in working hard.
• natural resources - countries are rich because they are abundant in natural resources.
• minerals, timber, favorable growing conditions.
Institutions as a fundamental cause
• North (1990): “institutions are the rules of the game in a society, or more formally, are the humanly devised constraints that shape human interactions.”
• Two types:
o political: structure of government, rule of law, certainty + stability
o economic: quality of markets, protection of property rights, certainty + stability
Property Rights and Political Stability
• recall: Markets are usually a good way to organize economic activity.
• the price system tends to allocate resources to their most efficient uses.
• this requires respect for property rights -> the ability of people to exercise authority over the resources they own.
• in many poor countries, the justice system doesn’t work very well:
• contracts aren’t always enforced.
o fraud + corruption often go unpunished.
o in some, firms must bribe government officials to get anything done -> licenses and permits, ability to hire employees, etc.
• political instability (e.g., frequent coups) creates uncertainty over.
whether property rights will be protected in the future.
More about property rights and political stability
• when people fear their stuff may be stolen by criminals or confiscated by a corrupt government:
o there is less investment, including from abroad o the economy functions less efficiently.
• result -> lower living standards.
• economic stability, efficiency, and healthy growth:
o require law enforcement;
o effective courts;
o functioning markets and a readily accepted currency;
o a stable constitution; and
• [relatively] honest government officials.
• take Eco 330 - Economics of Development - to learn more o or see me - this is my field!
Why are institutions useful?
• relying on rules and laws make the economy efficient: o increases predictability and reduces uncertainty.
o reduces costs for people seeking to guard their own property and for those seeking to appropriate others’ property (since they won’t succeed, they won’t try).
o people don’t have to pursue political power to gain commercial advantage.
Population Growth
• generally good for population to grow (moderately)
• a vibrant population promotes technological progress.
o more people
= more scientists, inventors, engineers
= more frequent discoveries
= faster technological progress & economic growth
Rev. Doom - the Rev. Thomas Malthus
• his 1798 work - An Essay on the Principle of Population - argued that population growth is exponential while the growth of the food supply is arithmetic.
• in other words, he predicted that population would grow faster than our ability to feed ourselves.
• he thought the natural way of things was that poor people would starve to death, restoring population balance.
More about Rev. Doom
• Malthus thought the natural way of things was that poor people would starve to death, restoring population balance.
• this was a common attitude of his time, when society thought that poor people were a problem to be managed, instead of people to be helped.
What did Rev. Doom advise
• population needed to be “checked” to keep it at a sustainable level. o “preventive checks” > moral restraints (abstinence, delayed marriage until finances become balanced), and restricting marriage for persons suffering from poverty and/or defects.
• population needed to be
“checked” to keep it at a sustainable level.
o “positive checks” >
‘premature’ death from disease, starvation, war.
Was Malthus right? Well, yes and no!
• Malthus argued that population growth would strain society’s ability to provide for itself.
• since his writing, the world population has increased six times!
o if Malthus’s theory was right, living standards should have fallen. o instead, they’ve risen.
• he was right, based on what he had observed up to the time he was
writing.
• BUT he was wrong because he failed to account for technological progress and productivity growth - he failed to observe the Industrial Revolution!
And eventually the great Norman Borlaug ..
• the most important person you’ve never heard of.
• US born agronomist.
• combatted crop disease and improved crop yields.
• helped increase food production in Latin America and Asia.
• the most important person you’ve never heard of.
• is credited for saving 1 billion+ lives (yes, you read that right).
• won Nobel Peace Prize in 1970
• “You can’t build peace on an empty stomach.
Malthus was not 100% wrong - population growth does have an effect
• diluting the capital stock
o bigger population -> higher L = lower K/L -> lower
productivity & living standards.
o this applies to Has well as K -> fast population growth -> more children - greater strain on educational system.
• countries with fast population growth tend to have lower educational attainment.
More on population growth
• diluting the capital stock - too many people, too little capital
• to combat this, many developing countries use policy to control population growth.
* o China’s one child law (since repealed)
o contraception education & availability
o promote female literacy to raise opportunity cost of having babies
But be careful - population growth that is TOO low can have disastrous results also!
• countries need to strike a balance.
Research and Development
• technological progress is the main reason why living standards rise over the long run.
• one reason is that knowledge is a public good -> ideas can be shared freely, increasing everyone’s productivity.
• policies to promote technological progress:
o patent laws (they protect inventions from being stolen and so encourage inventors to innovate).
o tax incentives or direct support for private sector R&D. o grants for basic research at universities.
The most successful venture capital firm in history
• it funded (among many other things) basic research leading to:
o the first computer o the internet o speech recognition software o mapping the human genome o solar and wind power improvements
• since 2010, the cost of
> solar power has dropped 85%
> wind power has dropped
50%.
In sum.
• in the long run, living standards are determined by productivity.
• policies that affect the determinants of productivity will therefore affect the next generation’s living standards.
• one of these determinants is saving and investment.
• next, we’ll look at how saving and investment are determined, and how policies can affect them.
