Ch 25. Production and Growth

.title[
# Ch 25. Production and Growth
]
.subtitle[
## Macroeconomics for Students of Accounting, Finance and Digital Applications
]
.author[
### Lyuben Ivanov, PhD; Georgy Ganev, PhD
]
.institute[
### Sofia University St Kliment Ohridski
]
.date[
### Mar 28, 2024
]

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.pull-right[
_Once you start thinking about economic growth, it is hard to think about anything else._
<hr style="background-color: black; margin: 0em 0em 0em 0em;">
<span style="float: right; font-variant: small-caps; ">Robert E. Lucas, Jr &nbsp;</span>
]

---

<hr>

---

# Economic Growth In the Long Run

<br>

There are two time horizons of economic activity of a
society:

-  A long-run trajectory of development of the society’s economy

-  The short-run fluctuations around this long-run trajectory

Both levels of observation, or time horizons of analysis,
are important, but different. They focus on and comprise
of different regularities and interdependencies. Therefore
they require different analytical approaches!!

Even small differences in growth rates in the long run
accumulate with the years and transform into very large
differences in wealth!

---

# The 'Hockey Stick' of Growth

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# Economic Growth in Various Countries

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# Stylized Facts About Long-Run Growth

The richest country in the world in 1870, by far, the UK, is now sixth even among this small sample of countries. In the world today
it is outside the top 10. This is due to much slower growth than
elsewhere.

The country with highest 148-year growth and the country with
lowest 148-year growth are one and the same country – Korea.
The difference between having almost 3 vs. less than 1
percent average annual growth translates 148 years later into
23 times higher living standard.

Even with an average annual growth of only 0.13 percentage
points higher than the world as a whole, a country like Bulgaria
has gone from being about 3% poorer than the world average
in 1870 to being a substantive more than 21% richer in 2018.

---

# Differences Over Time and Space

---

# The Endless Questions About Growth

&nbsp; &nbsp; &nbsp; **Q**: Why are some countries "rich" and others "poor"? <br>
&nbsp; &nbsp; &nbsp; **A**: Because of differences in productivity of labor.

&nbsp; &nbsp; &nbsp; **Q**: Why are workers in some countries more productive than workers in others? <br> 
&nbsp; &nbsp; &nbsp; **A**: Because of differences in human capital per worker, physical capital per worker, natural resources per worker, and technology.

&nbsp; &nbsp; &nbsp; **Q**: Why are some societies more inclined to invest in capital and adopt new technologies? <br>
&nbsp; &nbsp; &nbsp; **A**: Because of differences in geography, institutions and culture.

&nbsp; &nbsp; &nbsp; **Q**: Can (should) culture and institutions be changed? <br>
&nbsp; &nbsp; &nbsp; **A**: May be, with a lot of knowledge, determination and a great deal of luck!

---

<hr>

---

# Defining Key Concepts

<br>

<table class="none">
<tr>
    <td style="text-align: center; vertical-align: middle;"><b> productivity</b></td>
    <td> </td>
    <td> </td>
    <td>the quantity of goods and services produced from each unit of input</td>
  </tr>
  <tr>
  <td>
  <td>
  </tr>
  <tr>
    <td style="text-align: center; vertical-align: middle;"><b>(labor) productivity</b></td>
    <td> </td>
    <td> </td>
    <td>the quantity of goods and services produced from each unit of labor input</td>
  </tr>
</table>

<br>

More broadly **productivity** can be defined degree of human want satisfaction with a unit of spent scarce resource, while **labor productivity** is the degree of human want satisfaction with a unit of spent labor.

---

# The Production Function
<br>

`$$\begin{aligned}
\sf Y & = \sf A \times F(L,K,H,N) \\ \\
\sf \frac{Y}{L} & = \sf A \times F(1, \frac{K}{L},\frac{H}{L},\frac{N}{L}) \\ \\
\end{aligned}$$`
&nbsp; &nbsp; &nbsp; `$\sf Y$` &mdash; quantity of output <br>
&nbsp; &nbsp; &nbsp; `$\sf L$` &mdash; quantity of labor <br>
&nbsp; &nbsp; &nbsp; `$\sf K$` &mdash; quantity of physical capital <br>
&nbsp; &nbsp; &nbsp; `$\sf H$` &mdash; quantity of human capital <br>
&nbsp; &nbsp; &nbsp; `$\sf N$` &mdash; quantity of natural resources <br>
&nbsp; &nbsp; &nbsp; `$\sf A$` &mdash;  state of technology (multi factor productivity)

---

# Physical Capital Per Worker

<table class="none">
<tr>
    <td style="text-align: center; vertical-align: middle;"><b> physical capital </b></td>
    <td> </td>
    <td> </td>
    <td>the stock of equipment and structures that are used to produce goods and services</td>
  </tr>
</table>

More broadly, physical capital can be defined as the stock of produced material and non-material means of production and
structures, used by people to produce final consumer goods and services.

Physical capital is itself the result of production, and it is being
produced not to directly satisfy human wants, but to help more
productively produce the final goods that do.

What matters for productivity is not simply the presence of physical
capital, but its availability per worker, or per person employed.

---

# Human Capital Per Worker

<table class="none">
<tr>
    <td style="text-align: center; vertical-align: middle;"><b> human capital </b></td>
    <td> </td>
    <td> </td>
    <td>the knowledge and skills that workers acquire through education, training, and experience</td>
  </tr>
</table>

Human capital is a form of capital, i.e. of it is a **produced factor of production**, which is different from physical capital in that it is
embedded in the person of the worker and reflects her/his personal
abilities.

Like other forms of capital, human capital is a result of a production,
of utilizing scarce resource to achieve and enhance knowledge,
qualifications, abilities, skills. It requires sacrifice of current consumption.

Human capital has a very large contribution to labor productivity in the modern economy.

---

# Natural Resources Per Worker

<table class="none">
<tr>
    <td style="text-align: center; vertical-align: middle;"><b> natural resources </b></td>
    <td> </td>
    <td> </td>
    <td>the inputs into the production of goods and services that are provided by nature, such as land, rivers, and mineral deposits</td>
  </tr>
</table>

The major characteristic of natural resources is that they are not a
result of human production process, but are rather non-produced
presence in nature outside humans ("gifts of nature").

The availability of natural resources does have a significance for the
well-being and productivity of societies, but it seems to be less
important than other factors of production such as labor and the
various forms of capital. They can even be a "curse" under certain conditions!

---

# Technological Knowledge

<table class="none">
<tr>
    <td style="text-align: center; vertical-align: middle;"><b> technological knowledge </b></td>
    <td> </td>
    <td> </td>
    <td>society's understanding of the best ways to produce goods and services </td>
</tr>
</table>

In other words, technological knowledge is degree of understanding achieved in a given society about the possible ways of
transforming raw resources into final goods and satisfied human wants.

Organizational and transaction technologies have developed at least as much as transformative technologies over the last several centuries.

Technological knowledge is about the level of understanding available in the society as a whole (**common knowledge**) or in specific organizations/individuals (**proprietary knowledge**). Human capital is about the knowledge acquired by workers.

---

<hr>

---

# Proximate Versus Fundamental Causes

Factor accumulation, technology, and efficiency are *proximate* causes of a country’s level of income per capita. That is, they directly affect income in our model.

But what determines these proximate causes? The answer is the *fundamental* causes of income per capita. These are the factors that ultimately determine why some countries are rich and others are poor.

The fundamental determinants of income per capita are somewhat arbitrarily listed as follows:

1. Geography
2. Culture
3. Institutions

---

# Geography

<table class="none">
<tr>
    <td style="text-align: center; vertical-align: middle;"><b> geography hypothesis </b></td>
    <td> </td>
    <td> </td>
    <td>differences in geography, climate, and ecology are ultimately responsible for the major differences in prosperity
observed across the world</td>
  </tr>
</table>

Arguments supporting the geography hypothesis:

&nbsp; &nbsp; &nbsp; 1. **Climate effect**: tropical diseases, agricultural productivity

&nbsp; &nbsp; &nbsp; 2. **Natural resources effect**: oil, minerals, water

&nbsp; &nbsp; &nbsp; 3. **Access to water effect**: rivers, ports, distance from markets

&nbsp; &nbsp; &nbsp; 4. **Natural disasters effect**: earthquakes, hurricanes

---

# Culture

<table class="none">
<tr>
    <td style="text-align: center; vertical-align: middle;"><b> culture hypothesis </b></td>
    <td> </td>
    <td> </td>
    <td>the beliefs and values that are passed down from generation to generation are ultimately responsible for the major differences in prosperity observed across the world</td>
  </tr>
</table>

Arguments supporting the culture hypothesis:

&nbsp; &nbsp; &nbsp; 1. **Work ethic and education**: human capital

&nbsp; &nbsp; &nbsp; 2. **Trust**: social capital, transaction costs

&nbsp; &nbsp; &nbsp; 3. **Saving for the future**: human and physical capital, resource <br> &nbsp; &nbsp; &nbsp; conservation

&nbsp; &nbsp; &nbsp; 4. **Openness to new ideas**: entrepreneurship, technology <br> &nbsp; &nbsp; &nbsp; adoption

---

# Institutions

<table class="none">
<tr>
    <td style="text-align: center; vertical-align: middle;"><b> institutions </b></td>
    <td> </td>
    <td> </td>
    <td> the formal and informal rules governing the organization of a society, including its laws and regulations</td>
  </tr>
</table>

Three important elements define institutions:

&nbsp; &nbsp; &nbsp; 1. They are determined by individuals as members of a society.

&nbsp; &nbsp; &nbsp; 2. They place constraints on behavior.

&nbsp; &nbsp; &nbsp; 3. They shape behavior by determining **incentives**.

In some sense, institutions, much more than the other candidate fundamental causes, are about the importance of incentives!

---

# Institutions Hypothesis
<br>

<table class="none">
  <tr>
    <td style="text-align: center; vertical-align: middle;"><b> institutions hypothesis </b></td>
    <td> </td>
    <td> </td>
    <td> differences in institutions are ultimately responsible for the major differences in prosperity observed across the world</td>  
  </tr>
</table>

The institutions hypothesis relies on the following chain of reasoning:
1. Different societies typically have different institutions.

2. These different institutions create different types of incentives.
3. The incentives help determine the degree to which societies accumulate the factors of production and adopt new technology.

---

# Greatest Natural Experiment in History

---

# Economic Institutions

<br>

<table class="none">
  <tr>
    <td style="text-align: center; vertical-align: middle;"><b> economic institutions </b></td>
    <td> </td>
    <td> </td>
    <td> the aspects of the society’s rules that concern economic transactions</td>  
  </tr>
</table>  
  
--

Economic institutions include such things as the protection of property rights, the enforcement of contracts, the
functioning and impartiality of the judicial system, the financial arrangements that determine how individuals and businesses can borrow money, and the regulations that shape
how costly it is to enter into a new line of business or a new occupation.

---

# Political Institutions

<br>

<table class="none">
  <tr>
    <td style="text-align: center; vertical-align: middle;"><b> political institutions </b></td>
    <td> </td>
    <td> </td>
    <td> the aspects of the society’s rules that concern
the allocation of political power and the constraints on the exercise of
political power</td>  
  </tr>
</table>

Political institutions include such things as the right to vote, the right to run for political office, the right to free speech, the right to a fair trial, and the right to petition the government.

Some types of political institutions tend to support **extractive economic institutions**, while others tend to coexist with **inclusive economic institutions**.

---

# Inclusive Economic Institions

<table class="none">
  <tr>
    <td style="text-align: center; vertical-align: middle;"><b> inclusive economic institutions </b></td>
    <td> protect private property, uphold law and order, allow and enforce private contracts, and allow free entry into new lines of business and occupations </td>  
  </tr>
</table>

These institions are inclusive in the sense that they encourage the participation
of the great majority of the population in economic activities in a way that best
makes use of their talents and skills.

---

# Extractive Economic Institions

<table class="none">
  <tr>
    <td style="text-align: center; vertical-align: middle;"><b> extractive economic institutions </b></td>
    <td> do
not protect private property rights,
do not uphold contracts, and interfere
with the workings of markets,
also erect significant entry barriers
into businesses and occupations </td>  
  </tr>
</table>

Such institutions are often shaped by those who control
political power to extract resources from the rest of the society. Societies ruled by monarchs,
dictators, and juntas as well as several that hold elections for their parliaments
and
presidents have had, and still have, extractive economic
institutions. In fact, most societies
throughout history have had economic
institutions that are closer to the extreme extractive
economic
institutions of North Korea than to the ideal of inclusive economic
institutions
we have defined here.

---

# Logic of Extractive Institutions
<br>

<table class="none">
  <tr>
    <td style="text-align: center; vertical-align: middle;"><b> creative destruction </b></td>
    <td> </td>
    <td> </td>
    <td> refers to the
process in which new technologies
replace old ones, new businesses
replace existing businesses, and new
skills make old ones redundant </td>  
  </tr>
<tr>
<td> </td>
<td> </td>
<td> </td>
<td> </td>
</tr>
  <tr>
    <td style="text-align: center; vertical-align: middle;"><b> political creative destruction </b></td>
    <td> </td>
    <td> </td>
    <td> refers
to the process in which economic
growth destabilizes existing regimes
and reduces the political power of
rulers </td>  
  </tr>
</table>

---

# Logic of Extractive Institutions
<br>
<br>

.pull-right[
*We do not desire at all that the great masses shall
become well off and independent. . . . How could we
otherwise rule over them?*
<hr style="background-color: black; margin: 0em 0em 0em 0em;">
<span style="float: right; font-variant: small-caps; ">Frederick Gentz &nbsp;</span>
]

---

<hr>

---

# Public Policies

What aspects of the economy can government policy makers influence to raise productivity and living standards?

&nbsp; &nbsp; &nbsp; 1. Saving and investment.

&nbsp; &nbsp; &nbsp; 2. Education.

&nbsp; &nbsp; &nbsp; 3. Health and nutrition.

&nbsp; &nbsp; &nbsp; 4. Property rights and political stability.

&nbsp; &nbsp; &nbsp; 5. Free trade and investment from abroad.

&nbsp; &nbsp; &nbsp; 6. Research and development.

&nbsp; &nbsp; &nbsp; 7. Population growth.

---

# Case Study: Singapore

---

# Case Study: Singapore

.pull-right[
_I have emphasised this so often and I do not think you can over-emphasize this: that what we lack in numbers and size, we must make up for in quality. <br> <br>This is most important: quality._
<hr style="background-color: black; margin: 0em 0em 0em 0em;">
<span style="float: right; font-variant: small-caps; ">Lee Kuan Yew &nbsp;</span>
]

---

# Case Study: Singapore

<br>

.pull-right[
_Only people who a willing to face up to their problems, and are prepared to work with their leaders, to meet unexpected hardships with courage and resolution, only they deserve to thrive and to prosper._
<hr style="background-color: black; margin: 0em 0em 0em 0em;">
<span style="float: right; font-variant: small-caps; ">Lee Kuan Yew &nbsp;</span>
]

---

# Case Study: Bulgaria

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<hr>

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# The Parable of Sylvania and Freedonia

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# Questions?

<br>

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# Thank You!

<br>

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