GROWTH: Why Are Some Countries So Poor?

Introduction

Understanding the causes and consequences of economic growth is perhaps the most important undertaking in economics. Economic growth means an increase in standard of living (and at least some increase in happiness--see Economist article). With growth comes the ability to afford new medicine, a cleaner environment, and an easier life. With growth comes the hope that future generations will be better off than previous generations. Growth means that gadgets unimagined in youth may be possible later in life. Growth gives hope.

What, then, is economic growth? Growth is defined as the percentage change in a nations output, GDP. Formally, if we compare GDP between year one and two, the growth rate of GDP is:

Growth Rate = (GDP_year2-GDP_year1)/GDP_year1

Instead of using GDP, many economists look at the growth rate of GDP per capita (GDP divided by the population). Growth in GDP per capita means people's standard of living is increasing.

Three Growth Facts

1. The U.S. has the highest GDP per capita in the world, but not the highest growth rate.
In 1996, per capital GDP was $28,537 in the U.S. International comparisons are difficult, but countries close to the U.S. include Japan, Germany, Canada, and Luxembourg! However, these countries are not growing as fast as some others. Since 1960, U.S. per capital GDP, after adjusting for inflation, grew at an average growth rate of 2%. Japan averaged 5% growth while Mexico 2%. Over the last decade, many east Asian countries experienced growth of 8% (the recent crisis in the region has meant negative growth for most east Asian countries this year, however). Thus, many countries in the world are "catching up" to the U.S.
2. The Developed world has converged/ The Less Developed world has not.
There has been "catch-up" among most European countries. That is, the countries that had lowest per capita GDP level at the beginning of the century had the highest growth rates and tended to catch up to the leader (the U.S.). However, many countries, including much of Africa and India, have not gotten closer to the U.S. in per capita GDP.
3. Growth has slowed in the Developed world since 1973.
Most industrialized economies are growing much slower since the mid-1970s. A related development is the slowdown in the growth rate in worker productivity (defined as total output divided by total hours worked). Workers were becoming more productive at a rate of over 2.5% per year from WWII to 1973. Since then, the growth rate is less than 1%.

What Causes Growth?

GDP growth can be caused by two factors: 1) Increases in the number of inputs, and 2) Increases in technology. Inputs include labor, machinery, resources, trucks, and computers. Often, economists categorize inputs as either Labor or Capital. Technology is the way inputs are combined to make outputs (the final product). If technology increases, the same amount of inputs can produce more output. Both (1) and (2) lead to an increase in the production possibility frontier (PPF) which shows the possible combination of outputs an economy can produce when all inputs are used:

Which is more important for growth in output per person: Increases in the capital stock (an input) or increases in technology? Growth Accounting allows us to measure the contribution of both increased capital accumulation and technological progress to growth in per capital GDP. Economists are not in full agreement, but many estimate that two thirds of U.S. real GDP per capita growth is due to increases in technological progress, and one third due to increases in the capital stock.

Why do large differences exist between countries' per capita GDP? First, workers in developing countries are not as well equipped as workers in the U.S. Without a big capital stock, workers are less productive and output is not as great. Second, the developed world has pulled away with increases in technology. Indeed, the great success of the Industrial Revolution (for developed countries of the world) has been sustained growth through new invention and technology.

A recent book by Mancur Olson (see Economist article) claims that technology and capital have the best shot at promoting growth under specific political institutions.