Self-Check Questions

Compound interest and compound growth rates behave in the same way as productivity rates. Seemingly small changes in percentage points can have big impacts on income over time.

7.3 Components of Economic Growth

Over decades and generations, seemingly small differences of a few percentage points in the annual rate of economic growth make an enormous difference in GDP per capita. Capital deepening refers to an increase in the amount of capital per worker, either human capital per worker, in the form of higher education or skills, or physical capital per worker. Technology, in its economic meaning, refers broadly to all new methods of production, which includes major scientific inventions but also small inventions and even better forms of management or other types of institutions. A healthy climate for growth in GDP per capita consists of improvements in human capital, physical capital, and technology, in a market-oriented environment with supportive public policies and institutions.

7.4 Economic Convergence

When countries with lower GDP levels per capita catch up to countries with higher GDP levels per capita, we call the process convergence. Convergence can occur even when both high- and low-income countries increase investment in physical and human capital with the objective of growing GDP. This is because the impact of new investment in physical and human capital on a low-income country may result in huge gains as new skills or equipment combine with the labor force. In higher-income countries, however, a level of investment equal to that of the low income country is not likely to have as big an impact, because the more developed country most likely already has high levels of capital investment. Therefore, the marginal gain from this additional investment tends to be successively less and less. Higher income countries are more likely to have diminishing returns to their investments and must continually invent new technologies. This allows lower-income economies to have a chance for convergent growth. However, many high-income economies have developed economic and political institutions that provide a healthy economic climate for an ongoing stream of technological innovations. Continuous technological innovation can counterbalance diminishing returns to investments in human and physical capital.

Self-Check Questions

1 . Explain what the Industrial Revolution was and where it began. 2 . Explain the difference between property rights and contractual rights. Why do they matter to economic growth? 3 . Are there other ways in which we can measure productivity besides the amount produced per hour of work? 4 . Assume there are two countries: South Korea and the United States. South Korea grows at 4% and the United States grows at 1%. For the sake of simplicity, assume they both start from the same fictional income level, $10,000. What will the incomes of the United States and South Korea be in 20 years? By how many multiples will each country’s income grow in 20 years? 5 . What do the growth accounting studies conclude are the determinants of growth? Which is more important, the determinants or how they are combined? 6 . What policies can the government of a free-market economy implement to stimulate economic growth? 7 . List the areas where government policy can help economic growth. 8 . Use an example to explain why, after periods of rapid growth, a low-income country that has not caught up to a high-income country may feel poor. 9 . Would the following events usually lead to capital deepening? Why or why not? a. A weak economy in which businesses become reluctant to make long-term investments in physical capital. b. A rise in international trade. c. A trend in which many more adults participate in continuing education courses through their employers and at colleges and universities. 10 . What are the “advantages of backwardness” for economic growth? 11 . Would you expect capital deepening to result in diminished returns? Why or why not? Would you expect improvements in technology to result in diminished returns? Why or why not? 12 . Why does productivity growth in high-income economies not slow down as it runs into diminishing returns from additional investments in physical capital and human capital? Does this show one area where the theory of diminishing returns fails to apply? Why or why not?

Review Questions

13 . How did the Industrial Revolution increase the economic growth rate and income levels in the United States? 14 . How much should a nation be concerned if its rate of economic growth is just 2% slower than other nations? 15 . How is GDP per capita calculated differently from labor productivity? 16 . How do gains in labor productivity lead to gains in GDP per capita? 17 . What is an aggregate production function? 18 . What is capital deepening? 19 . What do economists mean when they refer to improvements in technology? 20 . For a high-income economy like the United States, what aggregate production function elements are most important in bringing about growth in GDP per capita? What about a middle-income country such as Brazil? A low-income country such as Niger? 21 . List some arguments for and against the likelihood of convergence.

Critical Thinking Questions

22 . Over the past 50 years, many countries have experienced an annual growth rate in real GDP per capita greater than that of the United States. Some examples are China, Japan, South Korea, and Taiwan. Does that mean the United States is regressing relative to other countries? Does that mean these countries will eventually overtake the United States in terms of the growth rate of real GDP per capita? Explain. 23 . Labor Productivity and Economic Growth outlined the logic of how increased productivity is associated with increased wages. Detail a situation where this is not the case and explain why it is not. 24 . Change in labor productivity is one of the most watched international statistics of growth. Visit the St. Louis Federal Reserve website and find the data section (http://research.stlouisfed.org). Find international comparisons of labor productivity, listed under the FRED Economic database (Growth Rate of Total Labor Productivity), and compare two countries in the recent past. State what you think the reasons for differences in labor productivity could be. 25 . Refer back to the Work It Out about Comparing the Economies of Two Countries and examine the data for the two countries you chose. How are they similar? How are they different? 26 . Education seems to be important for human capital deepening. As people become better educated and more knowledgeable, are there limits to how much additional benefit more education can provide? Why or