Chapter 17: Growth and Productivity--The Long-Run Possibilities

Supply side policies discussed in chapter 16 offer short-run solutions for non-inflationary increases in output. In this chapter we look at long-run increases in output. This growth in output is essential for a nation to maintain its living standards (as the population grows) or to improve living standards (if output rises faster than the population).

I.  Defining and Measuring Economic Growth

Short-run vs. Long-run Growth

Strictly speaking, economic growth is any increase in real GDP.

Temporary growth can occur from taking full advantage of existing production possibilities, or moving from a point INSIDE the production possibilities curve to a point ON the production possibilities curve:

Once the curve is hit, we reach full employment.

Further increases in growth occur only if we increase our productive capacity, shifting out the production possibilities curve:

Only this type of growth produces lasting increases in output and living standards.

Measuring the Growth Rate

Growth is measured by the percentage increase in real GDP per year. For example, U.S. real GDP at the end of 1997 was $8.29 trillion, while by the end of 1998 is was $8.73 trillion. The growth of the economy over that year was

Since the 1960s, the average annual rate of economic growth in the U.S. has fallen (seen figures 17.3 and 17.4, page 336). These growth rates are still large enough to keep per capita real GDP and thus living standards rising, but have caused concern about future living standards.

Much of this slowdown is attributed to a slowdown in labor productivity (output per labor-hour). Labor productivity measures how well labor is producing, rather than just how much labor there is. Again labor productivity has consistently risen but since the 1960s has risen at a slower rate. Since productivity affects wages, this slowdown has caused concern about the possibility of slower real wage growth in the U.S.:

What is behind falling productivity growth?  Some blame a failing education systems, others point out that our investment in infrastructure has fallen.  Still others blame too much government regulation.  However, part of the problem is with measurment.  recall that our economy has shifted from a manufacturing economy (making cars, sweaters, furniture, etc) to a service and information based economy (providing retail services, financial information, designing computer software).  Think about how you would measure output per labor-hour in an auto factory vs. a law office.  Measuring productivity in the service sector is difficult because measuring the "output" of service production is difficult.  How would you measure my productivity?  The number of classes I teach?  The number of students?  How long I prepare?  Hits to my course web page?

Productivity growth surged again in the 1990s.  This is in part due to better measurement in the service sector as well as the integration of computer technology across all types of industry, including the growth of the internet.

II.  Sources of Economic Growth

The growth rate depends on two things: how many people are producing and how well they are producing. This means that the growth rate depends on the growth of the labor force and the productivity of the labor force. Productivity gains come from several sources:

III.  Policies to Foster Economic Growth

The policies that foster economic growth can be anything that encourage growth in labor, capital, R&D, and the efficiency of resource use.

In terms the quantity and quality of the labor force, the federal government affects both through its immigration policy. The Immigration and Naturalization Service (INS) controls the number of immigrants as well as giving preference to immigrants with certain desired job skills, such as engineering or computer programming. At the federal, state and local level U.S. education policy also affects labor force quality.

The tax code is a means to encourage all of the sources of growth with favorable tax treatment of education spending, investment spending, R&D spending, and all types of saving. The government also directly affects the level of capital with infrastructure spending and its own R&D spending.

Fiscal and monetary policy also play a role. Maintaining stability in the macro economy reduces uncertainty and encourages investment. Fiscal restraint, i.e. a balanced budget, may also encourage investment by lowering interest rates (recall that deficits can crowd out private investment.)

IV.  Are there Limits to Growth?

Economists and environmentalists alike have expressed concern over the limits to population growth and economic growth, and whether vital natural resources will be exhausted in our lifetimes.

One of the earliest doomsday economists was Thomas Malthus. In 1798 he predicted that the population would increasingly grow at a faster rate than food production, leading to widespread famine. However he did not foresee the tremendous increases in agricultural productivity that allowed the growth in food production to exceed population growth.

The debate reignited in the 1970s with the books The Population Bomb by Paul Ehrlich and The Limits to Growth by a group of ecologists. The latter book made many doomsday predictions about the exhaustion of natural resources, predicting the world would run out of

Others have also contributed to the dire predictions: Needless to say, these doomsday scenarios have not materialized. Other economists, such as Julian Simon in The Ultimate Resource and Nobel Prize Winner Robert Solow, have refuted these claims, arguing that the discovery of new resource reserves, the development of substitutes, and more efficient usage mean there few, if any, limits to growth.

In fact, Simon and Ehrlich once made a famous bet where Simon bet Ehrlich that by 1990 metals would not be exhausted and that there price would actually decline, signaling that metals are LESS scarce. Simon won, and Ehrlich paid up. Simon offered to renew the bet, but Ehrlich refused.

FYI: Related Links

Are We Running Out of Oil? An easy-to-understand explanation of why predicting oil shortages is a misleading and futile exercise.

False Prophets of the Environment A critical look at doomsday scenarios of famine and resource exhaustion.

Productivity in the 1990s A discussion of whether productivity has risen in the 1990s or is mismeasured.