1. PRODUCTIVITY AND
GROWTH
MODULE 38

2. THE AGGREGATE PRODUCTION FUNCTION
 Productivity is higher when workers are
equipped with more physical capital, more
human capital, better technology, or any
combination of the three.
 In order to put numbers to productivity,
economists make use of estimates of the
aggregate production function which shows
how productivity depends on the quantities
of physical capital per worker and human
capital per worker as well as the state of
technology.

3. THE AGGREGATE PRODUCTION FUNCTION
 In general, all three factors of production
tend to rise over time, as workers are
equipped with more machinery, receive more
education, and benefit from technological
advances.
 The aggregate production function allows
economies to isolate the effects of these
three factors on overall productivity.

4. EXAMPLE OF AN AGGREGATE PRODUCTION
FUNCTION
 A comparative study of Chinese and Indian
economic growth used the following
aggregate production function:
*GDP per worker=T x (physical capital per
worker)0.4 x (human capital per worker)0.6
 Where T represented an estimate of the level
of technology and they assumed that each
year of education raised worker’s human
capital by 7%.
*study conducted by Barry Bosworth and Susan Collins of the
Brookings Institution

5. DIMINISHING RETURNS TO PHYSICAL
CAPITAL
 The estimated aggregate production function
exhibits diminishing returns to physical
capital.
 This means that when the amount of human
capital per worker and the state of
technology are held fixed, each successive
increase in the amount of physical capital
per worker leads to a smaller increase in
productivity.

6. DIMINISHING RETURNS TO PHYSICAL
CAPITAL
 A productivity curve shows a graphical
representation of the aggregate production
function, placing physical capital on the x-
axis and real GDP per worker on the y-axis.
 However, diminishing returns may disappear
if the amount of human capital is
increased, the technology improved, or
both, when the amount of physical capital is
increased.

7. DIMINISHING RETURNS TO PHYSICAL
CAPITAL
 Diminishing returns is a pervasive
characteristic of production.
 Typical estimates suggest that, in practice, a
1% increase in the quantity of physical
capital per worker increases output per
worker by only one third of 1%, or 0.33%.

8. GROWTH ACCOUNTING
 All the factors contributing to higher
productivity rise during the course of
economic growth: both physical capital and
human capital per worker increase, and
technology advances as well.
 Economists use growth accounting to
separate the different effects from each of
the three major factors in the aggregate
production function to economic growth.

9. EXAMPLE OF GROWTH ACCOUNTING
 Suppose that the amount of physical capital
per worker grows by 3% a year.
 If each 1% rise in physical capital per worker
will raise the output per worker by one-third
of 1%, then the 3% increase in physical
capital will be responsible for 1% or
productivity growth per year
(3% x 0.33 = 1%)
 Similarly, but more complex procedure is
used to estimate the effects of growing
human capital. It is more complex because
there are no simple $ measures of the
quantity of human capital.

10. GROWTH ACCOUNTING
 Growth accounting allows us to calculate the
effects of greater physical and human capital
on economic growth.
 Technological progress is measured by
estimating what is left over after the effects
of physical and human capital per worker
have been taken into account.

11. TOTAL FACTOR PRODUCTIVITY AND
TECHNOLOGICAL PROGRESS
 Total factor productivity refers to the amount
of output that can be achieved with a given
amount of factor inputs.
 When total factor productivity increases, the
economy can produce more output with the
same quantity of physical capital, human
capital, and labor.
 Increases in total factor productivity are
central to a country’s economic growth.

12. TECHNOLOGICAL PROGRESS
 Increases in total factor productivity in
fact, measure the economic effects of
technological progress.
 This implies that technological change is
crucial to economic growth.

13. NATURAL RESOURCES
 Other thing equal, countries that are
abundant in valuable natural resources have
higher GDP per capital than countries that do
not possess these resources.
 However, other things are not equal. It has
proven that natural resources are a much
less important determinant of productivity
than human or physical capital.
 Some nations with very real GDP per capita
have very few natural resources (such as
Japan) and some resource-rich countries are
very poor (such as Nigeria).

14. THOMAS MALTHUS
In An Essay on the Principle of
Population, English economist Thomas
Malthus expounded on the pessimistic
prediction about future productivity:
As population grew, he said, the amount of land
per worker would decline. This, other things
equal, would cause productivity to fall.
Malthus thought that improvements to physical
and human capital would only cause
temporary improvements in
productivity, because they would always be
offset by the pressure of rising population
and more workers on the limited supply of
land.

15. THOMAS MALTHUS
 However, it has not turned out this way.
 Although historians believe that Malthus
prediction of falling productivity was valid for
much of human history.
 However, any negative effects on
productivity from population growth have
been far outweighed by other positive
factors: advances in technology, increases
in human and physical capital, and the
opening up of enormous amounts of
cultivatable land.

16. THREE EXPERIENCES WITH
ECONOMIC GROWTH
 Rates of long-run economic growth differ
markedly around the world.
 Three countries are analyzed in terms of their
economic growth: Argentina, Nigeria, and
South Korea.
 Each was chosen as an example of what has
happened in their region.

17. SOUTH KOREA
 South Korea is often referred to as the East
Asian economic miracle. It has taken South
Korea only 35 years to achieve economic
growth that has taken centuries elsewhere.
 In 1960, South Korea was a poor nation.
However, in a space of about 30
years, reaching a growth of an average of 7%
per year in real GDP per capita.
 Today, although still poorer than either
United States or Europe, it has become an
economically advanced country.

18. THE ASIAN COUNTRIES
 Asian countries have achieved high growth
rates because all the sources of productivity
growth have been increases constantly:
1. Very high savings rates have allowed the
countries to significantly increase the
physical capital per worker.
2. Very good basic education have allowed a
rapid improvement in human capital.
3. Substantial technological progress
characterizes these countries.

19. THE ASIAN COUNTRIES
This East Asian experience demonstrates that
economic growth can be especially fast in
countries that are catching up with other
countries that have higher real GDP per
capita.
On this basis, economists suggest a general
principle known as the convergence
hypothesis.
According to the convergence
hypothesis, international differences in real
GDP per capita tend to narrow over time.

20. THE EAST ASIAN COUNTRIES
 This East Asian experience demonstrates that
economic growth can be especially fast in countries
that are catching up with other countries that have
higher real GDP per capita.
 On this basis, economists suggest a general
principle known as the convergence hypothesis.
 According to the convergence
hypothesis, international differences in real GDP per
capita tend to narrow over time because countries
that start with a lower real GDP per capita tend to
have higher growth rates (however, starting with a
low level of real GDP per capita is no guarantee of
rapid growth).

21. LATIN AMERICA
 In 1900, Latin America was not an economically
backward region. Natural resources were
abundant, including minerals and cultivatable
land.
 However, since about 1920, growth in Latin
America has been disappointing.
 The reasons for Latin America’s stagnation are
the opposite for the reasons for South Korea’s
success story.

22. LATIN AMERICA
 The rates of saving and investment spending in
Latin America have been much lower than in
East Asia:
1. Irresponsible government policy that has
eroded savings through high inflation, bank
failures, and other disruptions.
2. Education has been underemphasized.
3. Political instability has led to irresponsible
economic policies.

23. LATIN AMERICA
 In 1980, economists believed that Latin America
was suffering from excessive government
intervention in markets.
 They recommended opening the economies to
imports, selling government-owned companies,
and freeing up private initiative.
 However, only Chile has achieved rapid
economic growth.

24. AFRICA

25. AFRICA
 The explanation of this discouraging
situation results from:
1. The first and foremost problem has been
political instability. Wars have killed
millions of people and mad productive
investment spending impossible.
2. This threat of war and general anarchy have
also inhibited other important conditions for
growth, such as education and provision of
necessary infrastructure.

26. AFRICA
3. Property rights: the lack of legal safeguards
means that property owners are subject to
extortion because of government
corruption, so citizens are reluctant to own
or improve property.

27. AFRICA
While many economists believe that political
instability and government corruption are the
leading causes of underdevelopment in
Africa.
However, some economists, like Jeffrey
Sachs, believe that Africa is politically
unstable because it is poor.
He maintains that Africa’s poverty stems from
its extremely unfavorable geographic
conditions, as much of the continent is
landlocked, hot, infested with tropical
diseases, and cursed with poor soil.

28. AFRICA
The example of Africa represents a warning that
long-run economic growth cannot be taken for
granted.
However, some countries like Mauritius have been
able to achieve economic growth through
textile industry.
Several African nations that are dependent on
exporting commodities such as oil and coffee
have benefitted by their higher prices.
On a happier note: Africa’s economic
performance since the mid 1990’s has been
generally much better than it was in the
preceding decades.