Accounting for Growth: The Aggregate Production Function The aggregate production function is a hypothetical function that shows how productivity (real GDP per worker) depends on the quantities of physical capital per worker and human capital per worker as well as the state of technology.
Accounting for Growth: The Aggregate Production Function A recent example of an aggregate production function applied to real data comes from a comparative study of Chinese and Indian economic growth by the economists Barry Bosworth and Susan Collins of the Brookings Institution. They used the following aggregate production function:
Accounting for Growth: The Aggregate Production Function Using this function, they tried to explain why China grew faster than India between 1978 and 2004. They found that about half the difference was due to China’s higher levels of investment spending, which raised its level of physical capital per worker. The other half was due to faster Chinese technological progress.
Accounting for Growth: The Aggregate Production Function An aggregate production function exhibits diminishing returns to physical capital when, holding the amount of human capital and the state of technology fixed, each successive increase in the amount of physical capital leads to a smaller increase in productivity.
Accounting for Growth: The Aggregate Production Function A Hypothetical Example: How Physical Capital per Worker Affects Productivity, Holding Human Capital and Technology Fixed Physical capital per worker Real GDP per worker $0 $0 15,000 30,000 30,000 45,000 45,000 55,000
Physical Capital and Productivity Real GDP per worker 1. The increase in real GDP per worker becomes smaller … $60,000 C 50,000 B 30,000 A 0 $20,000 50,000 80,000 2. as physical capital per worker rises… Physical capital per worker (2000 dollars)
Accounting for Growth: The Aggregate Production Function Growth accounting estimates the contribution of each major factor in the aggregate production function to economic growth. The amount of physical capital per worker grows 3% a year. According to estimates of the aggregate production function, each 1% rise in physical capital per worker, holding human capital and technology constant, raises output per worker by 1⁄3 of 1%, or 0.33%. Total factor productivity is the amount of output that can be achieved with a given amount of factor inputs.
Technological Progress and Productivity Growth Real GDP per worker (2000 dollars) $120,000 Rising total factor productivity shifts curve up 90,000 60,000 30,000 0 $20,000 50,000 80,000 100,000 Physical capital per worker (2000 dollars)
What about Natural Resources? In the modern world, natural resources are a much less important determinant of productivity than human or physical capital for the great majority of countries. For example, some nations with very high real GDP per capita, such as Japan, have very few natural resources. Some resource-rich nations, such as Nigeria (which has sizable oil deposits), are very poor.
The Information Technology Paradox Why didn’t information technology show large rewards? • • • Many economists were puzzled by the slowdown in the U.S. growth rate of labor productivity. There was a fall from an average annual growth rate of 3% in the late 1960s to slightly less than 1% in the mid-1980s. This was surprising given that there appeared to be rapid progress in technology.
The Information Technology Paradox Robert Solow declared that the information technology revolution could be seen everywhere except in the economic statistics. Paul David suggested that a new technology doesn’t yield its full potential if you use it in old ways. He asserted that productivity would take off when people really changed their way of doing business to take advantage of the new technology—such as, replacing letters and phone calls with electronic communications. Sure enough, productivity growth accelerated dramatically in the second half of the 1990…
Success, Disappointment, and Failure The world economy contains examples of success and failure in the effort to achieve long-run economic growth. East Asian economies have done many things right and achieved very high growth rates. In Latin America, where some important conditions are lacking, growth has generally been disappointing. In Africa, real GDP per capita has declined for several decades (there are some signs of progress now).
Success, Disappointment, and Failure The growth rates of economically advanced countries have converged, but not the growth rates of countries across the world. This has led economists to believe that the convergence hypothesis fits the data only when factors that affect growth (i.e. education, infrastructure, and favorable policies and institutions) are held equal across countries.
Success, Disappointment, and Failure East Asia’s spectacular growth was generated by high savings and investment spending rates, emphasis on education, and adoption of technological advances from other countries. Poor education, political instability, and irresponsible government policies are major factors in the slow growth of Latin America. In sub-Saharan Africa, severe instability, war, and poor infrastructure— particularly affecting public health —have resulted in a catastrophic failure of growth.