Economics 201

Introduction to Macroeconomics

Mark Witte

Northwestern University

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Long Run Growth

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Life in Chicago used to be really bad

Long run growth (not recessions and booms)

Growth: Shifting out the PPF

Long Run Growth versus Fluctuations

Putting it in logs makes an exponential curve linear.

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The slope of the logged curve is the growth rate.

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For the US it has been very close to 2% for nearly 200 years.

Bill Bryson (writer)

“Thomas Marsham, a Norfolk clergyman ...was born in 1822 into a world of candlelight, medicinal leeches and travel no faster than a galloping horse.  He lived to see steamships, express trains, 'telegraphy, photography, anaesthesia, indoor plumbing, gas lighting, antisepsis in medicine, refrigeration, electric lights, recorded music, cars and planes, skyscrapers, radio' and much more besides."

Jeanne Louise Calment (1875-1997)

The oldest human on record reached the age of 122. She was a French woman, named Jeanne Louise Calment, and in her lifetime of 1875 to 1997, she got to witness an unprecedented period of innovation and growth human history. In 1875, the invention of radio was still decades away. In 1997, 70 million people were on the internet. She got to see changes in technology usually reserved for time travelers in the movies.

Robert Lucas (Nobel 1995)

"Is there some action a government of India could take that would lead the Indian economy to grow like Indonesia’s or Egypt’s? If so, what, exactly? If not, what is it about the 'nature of India' that makes it so? The consequences for human welfare involved in questions like these are simply staggering: Once one starts to think about them, it is hard to think about anything else." 

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Basic facts

• Force of compounding
• Slightly higher growth rates can close even huge differences in initial levels
• Korea versus Philippines 
• Rule of 70 or 72 or 69....
• The world became a very different place with the Industrial Revolution 
• Convergence

Rule of 70 in action

Rule of 70: The time it takes a variable to double is approximately 70 divided by that variable’s annual growth rate.

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• If per capita RGDP grows at 0% per year, the number of years it will take to double per capita income is...?

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• If per capita RGDP grows at 1% per year, the number of years it will take to double per capita income is...?

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• If per capita RGDP grows at 5% per year, the number of years it will take to double per capita income is...?

Where did the Rule of 70 come from?

Just for exposition. Don’t worry about this math.

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• Let RGDP grow at rate g, like g = 0.02
• How long will it take RGDP to double?  
• Suppose it take t years for RGDP to double
• RGDP_t = 2*RGDP_now =  RGDP_now*e^gt
• 2 = e^gt
• ln(2) = ln(e^gt) = gt
• t = ln(2)/g = 0.69/g
• For g = 0.02, t = 0.69/0.02 = (69%)/(2%)
• Which is pretty close to the much easier to compute (70%)/(2%) = 70/g% 

Bottom line: 70/(growth rate) is how long it takes for something to double in size

Clicker!

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Suppose that China's per capita RGDP is growing at 7% per year. How long will it take to double average incomes there?

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1) 5 years

2) 7 years

3) 10 years

4) 70 years

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How much does doubling time matter?

• 7% growth, doubling every 10 years
• 3.5% growth, 20 years to double.
• 10 versus 20, how big a deal is that?
• Consider what happens over the course of a century.

How much does doubling time matter?

• 7% growth, doubling every 10 years
• 3.5% growth, 20 years to double.
• 10 versus 20, how big a deal is that?
• Consider what happens over the course of a century.

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• A doubling time of 20 years means doubling 5 times in a century
• Which produces an increase by a factor of 32.

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How much does doubling time matter?

• 7% growth, doubling every 10 years
• 3.5% growth, 20 years to double.
• 10 versus 20, how big a deal is that?
• Consider what happens over the course of a century.

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• A doubling time of 20 years means doubling 5 times in a century
• Which produces an increase by a factor of 32.

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• Doubling 10 times produces an increase by a factor of 1024.

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2nd Millenium Econ Growth, not much before 1700

Things really begin to take off after 1870.

A cautionary note

How do people in countries with GDP per capita of $2/day survive?

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A cautionary note

How do people in countries with GDP per capita of $2/day survive?

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Because that’s $2/day of market activity.

People in poor countries do a lot of their work in home production, which is real production, but doesn’t count into GDP.

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So, some of the growth in GDP over time is just a move from home to market production, rather than something newly created.

Growth by region, from Robert Lucas

• Group I—basically, the English-speaking countries—are those in which per capita incomes first exhibited sustained growth. 
• Group II is Japan, isolated only to highlight its remarkable economic history. 
• Group III consists of northwest Europe, the countries that began sustained growth somewhat later than Group I. 
• Group IV is the rest of Europe, together with European-dominated economies in Latin America. 
• Group V contains the rest of Asia and Africa

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Growth by region

More recent results

Convergence?

Convergence?

Progress where it’s needed most

Progress where it’s needed most

Branko Milanović’s “Elephant”

Branko Milanović’s “Elephant”

Some innovators get super rich!

• Nordhaus (2004) finds that creators of technology are only able to capture about 2% of the economic value created by that technology
• The other 98% flows through to society in the form of what economists call social surplus.
• Who gets more value from a new technology, the single company that makes it, or the millions or billions of people who use it to improve their lives?
• Allcott, Ozaltun, Montanari, and Tan (October 2023)
• In a study of 74 firms in 12 industries, they consider the social impact caused by a firm’s exit
• The primary social impact (including profits, worker surplus, and externalities) is lost consumer surplus
• Existing ESG and social impact ratings are essentially unrelated to their economically grounded measures.

Paul Romer (Nobel 2018)

Missed opportunities.

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Why have so many countries not caught up?

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Problems from rent seeking? Corruption?

The Economy as a Production Function

• Output as a function of Kapital (K), Labor (N), and Productivity or Technology (A)
• Y = F(K,N,A)
• Embodied inputs:  Kapital, Labor
• Disembodied inputs:  Productivity, Technology
• Production is a positive function of each of these
• Probably constant returns over embodied inputs
• Twice the factories and workers, twice the output!
• 2*Y = F(2*K,2*N,A)
• Diminishing returns to individual embodied inputs

Capital per capita, Diminishing returns to K/Labor

As we increase K per worker, output per worker rises

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But at a decreasing rate

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This allows low income countries to catch up with richer ones because they start at a low K/worker ratio

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Kapital led growth!

Capital per capita: Diminishing returns to K/Labor

Capital is durable over time.

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Some percentage of it depreciates (δ), it wears out over time

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Capital grows over time as our saving and investment replaces the deprecated capital and adds new amounts

Effect of an increase in productivity

“Embodied” factors (K, Labor) have diminishing returns.

But Productivity does not!

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• Greater productivity = Higher output for a given amount of input

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• Arthur C. Clarke:  "Any sufficiently advanced technology is indistinguishable from magic."

For example….

For simplicity, suppose that we don’t have diminishing returns to capital.

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Let output per worker (Y/N) be given by this function:

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“A” stands for productivity and we’ll start with A = 1 and K/N = 100, so that Y/N = 30.

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As time goes by, K/N rises to be 200, but Y/N grows to be 100.

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What is the new level of productivity?

For example….

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We’ll start with A = 1 and K/N = 100, so that Y/N = 1*(10 + 0.2*100) = 30

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As time goes by, K/N rises to be 200, so we would expect: Y/N = 1*(10+0.2*200)= 50

but Y/N grows to be 100.

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What is the new level of productivity?

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Y/N = A*(10+0.2*200) = 100

Y/N = A*(50) = 100

A = 100/50 = 2

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Drivers of growth: Hsieh, Hurst, Jones & Klenow

50 years ago,

• 94% of physicians
• 96% of lawyers
• 99% of engineers,
• 86% of corporate managers and execs were....

Drivers of growth: Hsieh, Hurst, Jones & Klenow

50 years ago,

• 94% of physicians
• 96% of lawyers
• 99% of engineers,
• 86% of corporate managers and execs were....

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Now it's down to

• 63% of physicians,
• 61% of lawyers,
• 57% of corporate execs

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And trending down!

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Drivers of growth: Hsieh, Hurst, Jones & Klenow

50 years ago,

• 94% of physicians
• 96% of lawyers
• 99% of engineers,
• 86% of corporate managers and execs were....

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Now it's down to

• 63% of physicians,
• 61% of lawyers,
• 57% of corporate execs

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And trending!

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Drivers of growth: Hsieh, Hurst, Jones & Klenow

• In 1960, 20% of white men worked in high skill industries
• While only 2 to 6% of working white women, or African Americans worked in such jobs then
• 58% of working white women were nurses, teachers, sales clerks, secretaries or food preparers
• 51% of working black men were freight handlers, drivers, machine operators, farm laborers, janitors
• 51% of working black women were in household services, personal services, food preparation

Drivers of growth: Hsieh, Hurst, Jones & Klenow

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Drivers of growth: Hsieh, Hurst, Jones & Klenow

15-20% of US growth in the last 50 years from allowing getting the best suited people to move into the right jobs

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Going forward, how much does it matter?

Christine Lagarde

Head of European Central Bank

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• If men and women were on par in the US, it would increase our real GDP by 5%
• For Japan, it would be 9%
• For Turkey, 22%
• For India, 27%
• Also reduces income inequality

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NU’s Robert Gordon: Future US growth will be slow

Which is the outlier?

Gordon’s math

NU Econ & History prof Joel Mokyr

Mokyr: Don’t worry too much!

• What brought on the Enlightenment was the generation and sharing of knowledge
• And people being open to accepting that!
• Modern society is moving into an unprecedented time for doing just that

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Simon Kuznets: Growth & Inequality

Simon Kuznets: Growth & Inequality

• Very low income societies often have a lot of equality
• Virtually everyone is poor
• Growth often happens because some people grow richer, leaving the poor behind
• This leads to greater inequality
• Kuznets: Early growth is from the richer moving away from the poor in income
• Later growth is the poor catching up to the rich
• Allegedly….

Up next….

Savings and Investment