The World Economy

Total GDP (2012): $83T Population (2012):7B GDP per Capita (2012): $12,500 Population Growth (2012): 1.1% GDP Growth (2012): 3.3%

GDP per capita is probably the best measure of a country’s overall well being

Region GDP % of World GDP

GDP Per Capita

Real GDP Growth

United States $15T 18% $48,000 1.3%

European Union $16T 19% $33,000 1.0%

Japan $4.3T 6% $34,200 -.4%

China $7.8T 11% $6,000 9.8%

India $3.2T 5% $2,800 6.6%

Ethiopia $66.3B .09% $800 8.5%

Note. However, that growth rates vary significantly across countries/regions. Do you see a pattern here?

Source: CIA World Factbook

At the current trends, the standard of living in China will surpass that of the US in 25 years! Or, will they?

Per

Cap

ita

Inco

me

That is, can China maintain it’s current growth rate?

Income GDP/Capita GDP Growth

Low $510 6.3%

Middle $2,190 7.0%

High $32,040 3.2%

As a general rule, low income (developing) countries tend to have higher average rates of growth than do high income countries

The implication here is that eventually, poorer countries should eventually “catch up” to wealthier countries in terms of per capita income – a concept known as “convergence”

Some countries, however, don’t fit the normal pattern of development

SudanGDP: $80B (#80)GDP Per Capita: $2,400 (#184)GDP Growth: -11.2% (#219)

QatarGDP: $150B (#59)GDP Per Capita: $179,000 (#1)GDP Growth: 16.3% (#1)

So, what is Sudan doing wrong? (Or, what is Qatar doing right?)

At current trends, Per capita income in Qatar will quadruple to $716,000 over the next decade. Over the same time period, per capita GDP in Sudan will drop by roughly 40%to $670!!!

To understand this, let’s look at the sources of economic growth….where does production come from?

LKAFY ,,Real GDP

“is a function of”

Productivity Capital Stock

Labor

Real GDP = Constant Dollar (Inflation adjusted) value of all goods and services produced in the United States

Capital Stock = Constant dollar value of private, non-residential fixed assets

Labor = Private Sector Employment

Productivity = Production unaccounted for by capital or labor

A convenient functional form for growth accounting is the Cobb-Douglas production function. It takes the form:

LAKY where 1

With the Cobb-Douglas production function, the parameters have clear interpretations:

Capital’s share of income (what % of total income in the US accrues to owners of capital)

Labor’s share of income (what % of total income in the US accrues to owners of labor)

Elasticity of output with respect to capital (% increase in output resulting from a 1% increase in capital)

Elasticity of output with respect to labor (% increase in output resulting from a 1% increase in labor)

3

2

3

1

LAKY

Suppose we have the following Cobb-Douglas production function:

A 1% rise in employment raises GDP by 2/3%

A 1% rise in capital raises GDP by 1/3%

We can rewrite the production function in terms of growth rates to decompose GDP growth into growth of factors:

LKAY %3

2%

3

1%%

Real GDP Growth (observable) Employment

Growth (observable)

Capital Growth (observable)

Productivity Growth (unobservable)

Year Real GDP (Billions of 2000 dollars)

Real Capital Stock (Billions of 2000 dollars)

Employment (thousands)

1939 1,142 1,440 29,923

2006 11,257 12,632 135,155

2007 11,467 12,883 137,180

Lets decompose some recent data first…

85.1100*257,11ln467,11ln% Y

97.1100*632,12ln883,12ln% K

48.1100*155,135ln180,137ln% L

Note that capital is growing faster than employment

20.48.13

297.1

3

185.1% A

Year Real GDP (Billions of 2000 dollars)

Real Capital Stock (Billions of 2000 dollars)

Employment (thousands)

1939 1,142 1,440 29,923

2006 11,257 12,632 135,155

2007 11,467 12,883 137,180

Now, lets look at long term averages

39.3100*

68

142,1ln467,11ln%

Y

22.3100*

68

440,1ln883,12ln%

K

23.2100*

68

923,29ln180,137ln%

L

84.23.23

222.3

3

139.3% A

1939 - 1948 1948 - 1973 1973-1993 1993-2007

Output 5.79 4.10 1.96 2.63Capital 3.34 4.24 2.10 2.94Labor 4.46 2.10 1.86 1.60Productivity 1.71 1.28 0.02 0.59

A few things to notice:

Real GDP growth is declining over time.

Capital has been growing faster than labor

The contribution of productivity is diminishing!

Contributions to growth from capital, labor, and technology vary across time period

Our model of economic growth begins with a production function

Real GDP

Productivity Capital Stock

Labor

Given our production function, economic growth can result from

• Growth in Labor• Growth in the capital stock• Growth in Productivity

3

2

3

1

LAKY

We are concerned with capital based growth. Therefore, growth in productivity and employment will be taken as given

Productivity grows at rate

AgPop

Pop

LF

LF

LL

Population grows at rate

Lg

Employment

Labor Force= Employment Ratio

( Assumed Constant)

Labor Force

Population= Participation rate

( Assumed Constant)

3

2

3

1

LAKY

Our simple model of economic growth begins with a production function with one key property

Y

K

),,( LKAF

As the capital stock increases (given a fixed level of employment), the productivity of capital declines!!

K

YMPK

Change in Capital Stock

Change in Production

An economy can’t grow through capital accumulation alone forever!

3

2

3

1

LAKY

K

Y

K

Y

Everything in this model is in per capita terms

3

2

3

1

LAKY Divide both sides by labor to represent our variables in per capita terms

3

13

1

3

2

3

1

3

2

3

1

AkL

KA

LL

LAK

L

Yy

Capital Per Capita

Productivity

Per capita output

In general, let’s assume lower case letters refer to per capita variables