ECO37W1 | Macro Growth Notes | Exam Ready

ECO37W1 — ECONOMIC THEORY

MACRO 3 & 4
ECONOMIC GROWTH — COMPLETE EXAM NOTES

EXAM PRIORITY — WHAT THE LECTURER SAID

Growth took most of macro. Assignments were on growth. Presentations were on growth — that is a major
clue.

Questions will ask: 'Which growth theory applies to South Africa?' — first explain the theory, THEN apply to
SA.

DO NOT jump straight to SA examples — explain the theory first, then connect it to SA.

Factors affecting growth, technological innovation, savings-capital-output, and endogenous growth theory
are ALL in scope.

SECTION 1: WHAT IS ECONOMIC GROWTH?

Economic growth means a country is producing more goods and services over time. It is one of the most important
goals in macroeconomics because it creates jobs, reduces poverty, increases government income, and improves the
lives of people.

Economic growth is measured using:

• Real GDP — total value of goods and services produced

• Real GDP per capita — GDP divided by the population (better measure of living standards)
• Output per worker — how much each worker produces (measures productivity)

GDP per capita is more useful than total GDP because countries have different population sizes. A country can have a
large GDP but if the population is also very large, each person still earns very little. GDP per capita shows the average
income per person.

PURCHASING POWER PARITY (PPP)

PPP adjusts GDP figures so that we can compare living standards across countries fairly.

R100 in South Africa buys more than R100 in the United States because prices are different.

PPP removes these price differences so that comparisons are meaningful.

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SECTION 2: THE AGGREGATE PRODUCTION FUNCTION

The aggregate production function shows the relationship between what an economy produces (output) and what it
uses to produce it (inputs).

The basic production function is:

Y = F(K, N)

Variable What it means

Y Output — everything the economy produces

K Capital — machines, factories, buildings, equipment

N Labour — the number of workers

F The production function — depends on the level of

technology

A country with better technology produces MORE output using the SAME amount of capital and labour. This is why
technology is so important for growth.

Returns to Scale

Constant returns to scale: if you double both capital AND labour, output also doubles. The economy is using its
inputs efficiently.

Decreasing returns to capital: if you keep adding more capital while labour stays the same, each extra unit of capital
adds less and less output. This is called diminishing returns.

KEY EXAM POINT — Diminishing Returns

Because of diminishing returns to capital, capital accumulation alone CANNOT sustain growth forever.

At some point, extra capital barely increases output. Growth slows and eventually stops.

This is why technological progress is the ONLY way to sustain long-run growth.

SECTION 3: SOURCES OF ECONOMIC GROWTH

Economic growth comes from two main sources:

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Source What it means Long-run growth?

Capital accumulation Building more factories, buying more NO — diminishing returns

machines, expanding infrastructure eventually stop growth

Technological progress Producing more with the same inputs through YES — technology is the only
better methods, innovation, and knowledge permanent source of long-run
growth

Capital accumulation increases output in the short and medium run. But because of diminishing returns, growth
eventually slows. Technological progress is different — it shifts the entire production function upward, meaning
more output is possible from the same inputs, permanently.

SA APPLICATION — Capital vs Technology

South Africa has invested in capital over the years — roads, ports, power stations — but growth has
remained below 2% per year since 2012.

This is consistent with the theory: capital accumulation without technological progress leads to diminishing
returns.

Load-shedding (Eskom failure) shows that even existing capital becomes useless without maintenance and
innovation.

SA's path to higher growth must go through technology, education, and innovation — not just more physical
infrastructure.

SECTION 4: GROWTH THEORIES — KNOW ALL FIVE

EXAM TECHNIQUE — Growth Theory Questions

Step 1: Explain each theory clearly (what drives growth, what happens in the long run).

Step 2: State which theory applies to SA and WHY — give specific SA evidence.

Step 3: Acknowledge that more than one theory may apply partially.

NEVER jump straight to SA. Theory first, then application.

Comparison Table — All Growth Theories

Theory What drives growth Long-run SA applicability

growth?

Classical (Smith, Land, labour, capital. Population NO — growth Partially — explains SA's
Malthus) growth leads to resource stops eventually resource pressure and

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pressure and eventually a population challenges but

stationary state. underestimates technology

Neoclassical / Solow Savings → investment → capital Only through Partially — savings and
accumulation → output. external investment matter but
Technology is external. technology technology treated as an
outside gift

Keynesian Aggregate demand — Short-run only YES for recessions — SA's

government spending and high unemployment and
investment stimulate output and weak demand suit
employment. government stimulus

Structural Moving from low-productivity YES if YES — SA still depends too

agriculture to manufacturing and transformation much on mining and raw
services (industrialisation). happens exports. Needs
manufacturing growth.

Endogenous Human capital, R&D, knowledge, YES — MOST APPLICABLE — SA's

and innovation created from permanently, no core problem is skills,
WITHIN the economy. limit innovation, and institutional
quality

1. Classical Growth Theory

Classical economists like Adam Smith, David Ricardo, and Thomas Malthus argued that growth depends on land,
labour, and capital. Thomas Malthus specifically warned that population grows faster than food production, leading
to poverty and resource shortages over time.

The main problem with classical theory is that it underestimates technology. Malthus predicted mass starvation as
populations grew — but agricultural technology advanced faster than population, disproving his prediction.

SA APPLICATION — Classical Theory

Classical theory partly applies to SA through population pressure on resources and high unemployment.

SA's growing population increases demand for food, water, and energy — placing strain on natural
resources.

However, classical theory cannot explain why some countries (Japan, South Korea) grew rich with few
natural resources.

2. Neoclassical / Solow Growth Theory

Robert Solow developed this model. It shows that savings lead to investment, investment increases the capital stock,
and more capital raises output. However, because of diminishing returns to capital, the economy eventually reaches
a steady state — where output per worker stops growing.

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At the steady state, the only way to keep growing is through technological progress. But in the Solow model,
technology comes from OUTSIDE the model — it falls like rain from the sky. This is the main weakness.

STEADY STATE — What it means

The steady state is the long-run equilibrium where output per worker and capital per worker are constant.

At the steady state: new investment only replaces worn-out capital — it does not increase the capital stock.

Without technological progress, an economy at the steady state has ZERO long-run growth.

A higher saving rate can raise the steady-state LEVEL of output per worker but not the long-run GROWTH
RATE.

SA APPLICATION — Solow Theory

The Solow model applies to SA because savings and investment clearly matter — SA's low saving rate limits
capital accumulation.

However, Solow cannot explain why SA remains poor despite some capital investment — the missing piece is
technology and human capital.

Compare: SA saving rate ≈ 0.5% of disposable income. China saving rate ≈ 35-40%. China grew at 9%+ for
decades.

3. Keynesian Growth Theory

Keynes argued that the main driver of growth is aggregate demand — the total spending in the economy. When
demand is too low, businesses produce less, hire fewer workers, and growth slows. Government can fix this by
spending more (fiscal policy) to boost demand directly.

This theory is mostly about the short run. It explains recessions and unemployment well but does not fully explain
long-run growth.

SA APPLICATION — Keynesian Theory

Keynesian theory is very relevant for SA right now because unemployment is above 32% and consumer
spending is weak.

SA's social grants (SASSA) and government infrastructure spending are Keynesian tools — they inject demand
into the economy.

The SARB cutting interest rates during COVID-19 (from 6.5% to 3.5%) was a Keynesian-inspired demand
stimulus.

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However, SA's budget deficit and rising debt show the risk of excessive government spending — it can
become unsustainable.

4. Structural Growth Theory

This theory says that for a country to grow sustainably, it must change its economic structure — moving workers and
resources from low-productivity sectors (like subsistence farming) into higher-productivity sectors like
manufacturing, services, and technology.

Countries that successfully industrialise — South Korea, Taiwan, China — move up the value chain from raw material
exports to manufactured goods to high-technology products.

SA APPLICATION — Structural Theory

SA's economy is still heavily dependent on mining and raw commodity exports — a classic developing
economy structure.

Manufacturing's share of SA's GDP has DECLINED over the past two decades — de-industrialisation, not
industrialisation.

SA needs to move workers from low-productivity informal work into formal manufacturing and technology
services.

Special Economic Zones (SEZs) and industrial policy are structural theory prescriptions SA is trying to
implement.

5. Endogenous Growth Theory — MOST IMPORTANT FOR EXAM

Endogenous growth theory was developed as a response to Solow's main weakness — treating technology as
external. Endogenous growth says that technology, knowledge, and innovation are created FROM WITHIN the
economy through deliberate choices.

Key idea: when people invest in education, when firms invest in R&D, when governments fund research — they are
producing new knowledge. Knowledge is different from physical capital because it does NOT face diminishing
returns. One person using knowledge does not reduce the knowledge available to others.

This means that if a country continuously invests in human capital and R&D, it can achieve permanently higher
growth — there is no steady state ceiling as in the Solow model.

Solow (Neoclassical) Endogenous Growth

Technology comes from outside the model Technology is created inside the economy through
R&D and education

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Capital faces diminishing returns — steady state Knowledge does not diminish — no growth ceiling

Government policy has limited long-run effect Government policy permanently affects the growth
rate

Saving rate affects the level of output, not growth Spending on education and R&D affects the long-run
rate growth rate

SA APPLICATION — Why Endogenous Theory is Most Applicable

SA's problem is NOT lack of physical capital — it is lack of skills, innovation capacity, and institutional quality.

Brain drain: over 900 000 skilled South Africans live abroad — the very people endogenous growth depends
on.

R&D spending: SA spends about 0.6% of GDP on R&D vs 3%+ in technology-leading countries like South
Korea.

Poor education outcomes: over 80% of Grade 4 learners cannot read for meaning (World Bank) — human
capital foundation is weak.

NSFAS university funding and TVET college expansion are correct endogenous growth policies — investing in
human capital.

US cuts to African university research funding directly reduce SA's capacity to generate internal technological
progress.

Japan proves the point: NO natural resources after WWII, cities bombed — yet became world's second-
largest economy through human capital + technology investment alone.

EXAM ANSWER STRUCTURE — 'Which theory applies to SA?' (15-20 marks)

Para 1: Define economic growth (2 lines only).

Para 2-3: Explain each theory briefly — 2-3 sentences each. Classical, Neoclassical, Keynesian, Structural,
Endogenous.

Para 4: State your answer — endogenous growth is most applicable. Give 3-4 specific SA reasons with
evidence.

Para 5: Acknowledge other theories apply partially (Keynesian for short run, Structural for industrialisation).

Para 6: Conclude — SA's sustainable growth requires internal investment in people, knowledge, and
institutions.

SECTION 5: FACTORS AFFECTING GROWTH

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EXAM PRIORITY — This question WILL appear

The lecturer said: 'Discuss and explain how the following factors affect growth.'

For EACH factor: (1) define it, (2) explain the mechanism, (3) give a specific SA example, (4) mention positive
AND negative effects.

The 5 factors: Population, Natural Resources, Human Capital, Technology, Institutional Factors.

1. Population

Population affects growth through the size and structure of the labour force. It is not just about how many people
there are — what matters most is the STRUCTURE of the population.

A large working-age population (people aged 15-64 who are employed) produces output and drives economic
growth. A population made up mainly of children and elderly people consumes goods but does not produce — this is
called a high dependency ratio and it slows growth.

KEY DISTINCTION — The lecturer specifically said this

Children increase CONSUMPTION but do NOT contribute to PRODUCTION.

A large population of children = more food, clothing, and services needed = more pressure on the economy.

A large WORKING-AGE population that is employed = more production = higher output = growth.

The dependency ratio = (children + elderly) divided by working-age population.

High dependency ratio = more dependants per worker = slower growth per capita.

SA APPLICATION — Population

SA has a young population — over 20 million people are under the age of 15.

Youth unemployment rate: over 45% for ages 15-34. This means even working-age South Africans are not
producing.

This creates a double problem: high dependency ratio AND low labour force participation among young
people.

If SA can educate and employ its young population, it could experience a demographic dividend — rapid
growth from a large productive workforce.

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BUT without jobs and skills, the young population becomes a social burden — increasing grant dependency
and instability, which then reduces investor confidence and growth.

2. Natural Resources

Countries with abundant natural resources have the potential to grow faster because resources can be extracted,
sold, and used to fund investment. Natural resources include minerals, water, fertile land, forests, oil, and coal.

However, natural resources are not a guarantee of growth. Many resource-rich countries actually grow SLOWER
than resource-poor countries — this is called the resource curse.

Positive effects Negative effects

Export earnings bring foreign exchange into the Over-dependence on one sector makes the economy
country vulnerable to price shocks

Mining and resource industries create jobs Dutch Disease: resource exports push up the
exchange rate, making other exports uncompetitive

Government earns taxes from resource companies to Resource wealth attracts corruption and rent-seeking
fund services — political elites fight to control resource revenues

Resources can fund investment in other sectors Environmental damage from extraction has long-run
costs on agriculture and water supply

Dutch Disease explained simply: when SA exports a lot of gold and platinum, foreign buyers need rands to pay for
them. High demand for rands pushes the rand's value up. A stronger rand makes SA's other products (like cars and
food) more expensive for foreign buyers — so those industries struggle and shrink.

SA APPLICATION — Natural Resources

SA is rich in gold, platinum, diamonds, and coal. Mining historically drove SA's economic development.

BUT: mining's share of GDP has been declining for decades as reserves deplete and mines go deeper.

Dutch Disease evidence: strong rand during commodity booms (2004-2008) hurt SA's manufacturing exports.

Acid mine drainage in the Witwatersrand: gold mining left behind toxic water contaminating rivers — a long-
run cost never included in mining profits.

New opportunity: platinum demand for hydrogen fuel cells is growing — SA has 80% of world's platinum
reserves. If managed well, this could fund a new growth phase.

Resource curse: corruption in mining licensing and BEE deals has meant resource wealth has not reached
most South Africans.

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3. Human Capital

Human capital refers to the education, skills, training, and experience that workers have. A more skilled and
educated workforce produces more output per worker, adapts to new technology more easily, and drives
innovation.

Human capital is accumulated through education, training programmes, and work experience. Unlike physical
machines, human capital goes home with the worker every day — and if workers emigrate (brain drain), the country
loses that capital entirely.

Japan vs South Africa — The Lecturer Specifically Mentioned This

Japan South Africa

No natural resources after World War 2. Cities were Rich in natural resources — gold, platinum, coal,
destroyed. diamonds.

Invested heavily in universal high-quality education. Education spending is high (about 6% of GDP) but
quality is poor.

Strong focus on engineering and technical skills. Skills mismatch: graduates not matched to what the
economy needs.

Technology imitation in the 1950s-60s, then Still mostly a technology importer — low R&D and
innovation from the 1970s. innovation.

Became world's second-largest economy through Unemployment above 32%, productivity low, brain
human capital alone. drain ongoing.

Result: sustained high growth for decades. Result: growth below 2% per year since 2012.

Japan's story is the clearest proof that natural resources are not what makes a country grow. Japan had nothing —
but invested in its people. The result was world-class productivity and sustained growth. SA has the resources but
has not invested enough in the quality of its human capital.

SA APPLICATION — Human Capital

Over 80% of South African Grade 4 learners cannot read for meaning — this is the foundation of the human
capital problem.

University graduates are produced in large numbers but many are not skilled in what the economy needs
(engineering, data science, artisan trades).

Brain drain: an estimated 900 000+ skilled South Africans work abroad — doctors, engineers, IT
professionals, scientists.

NSFAS (National Student Financial Aid Scheme) is the correct policy response — it builds human capital by
enabling access to higher education.

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TVET (Technical and Vocational) colleges provide artisan training — critical for building the skilled trades
workforce SA lacks.

4. Technology and Innovation

Technology is the most important long-run driver of economic growth. It allows an economy to produce more
output from the same amount of capital and labour. Unlike capital, technology does not face diminishing returns —
it can keep improving output indefinitely.

Technology works through three channels:

• Invention — creating completely new knowledge or products

• Innovation — turning new knowledge into actual products and production processes
• Adoption — spreading existing technology across firms and workers

Advanced countries must INNOVATE because they are already at the technology frontier — there is no one ahead to
copy from. Developing countries like SA can grow faster by IMITATING — importing and adapting technology that
already exists elsewhere. This is cheaper and less risky than inventing from scratch.

SA APPLICATION — Technology

SA is currently a technology imitator — it imports most of its technology from developed countries.

Low R&D spending: SA spends about 0.6% of GDP on R&D vs 3%+ in South Korea and Japan.

The 4th Industrial Revolution (AI, robotics, automation) is a risk for SA because low-skill manufacturing jobs
are being automated — and SA's workforce is not ready for higher-skill alternatives.

Load-shedding directly destroys technological progress — firms cannot adopt new digital systems when
electricity is unreliable.

Positive potential: SA's fintech sector (like TymeBank, Capitec's digital model) and renewable energy sector
show innovation is possible when conditions allow.

5. Institutional Factors

Institutions are the rules, laws, and systems that govern how the economy works. Good institutions create an
environment where people and businesses can invest confidently because they know their property is protected,
contracts will be honoured, and the government is accountable.

Bad institutions create uncertainty — investors do not know if their money is safe, if contracts will be respected, or if
the rules will change suddenly. This drives investment away and slows growth.

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Good institutions — support growth Bad institutions — hurt growth

Clear property rights — investors know what they Unclear property rights — investors hesitate to invest
own

Rule of law — contracts enforced, courts work Weak rule of law — contracts unreliable, corruption
unpunished

Political stability — businesses plan long-term Political instability — uncertainty, rand weakens,
investment falls

Low corruption — resources go to productive use High corruption — resources stolen, services fail

Good governance — efficient public services Poor governance — load-shedding, failing

infrastructure

SA APPLICATION — Institutional Factors

State capture at Eskom: the Zondo Commission found R49 billion looted — Eskom was weakened, load-
shedding followed, GDP losses from load-shedding estimated at R20-50 billion per year.

Transnet: R27 billion in irregular contracts — rail and port infrastructure broke down — mining companies
could not export their products — export revenue fell.

Land reform uncertainty: unclear property rights in agriculture make investors cautious about farming
investments.

What works well: the South African Reserve Bank (SARB) is independent and credible — this keeps inflation
expectations stable and supports investment confidence.

The Constitutional Court provides legal certainty — foreign investors can still rely on contract enforcement in
SA's legal system.

Political instability signal: cabinet reshuffles, policy changes, and ANC internal battles cause the rand to
weaken — imported inflation rises — SARB raises rates — investment slows.

SECTION 6: TECHNOLOGICAL INNOVATION — DETERMINANTS

The lecturer specifically said determinants of technological innovation are in scope. A question could ask: 'What
factors determine a country's ability to innovate?'

The Key Determinants:

Determinant What it means and SA link

R&D Spending Firms invest in research and development only if they

can profit from the results. More R&D = more
innovation. SA spends 0.6% of GDP on R&D — far too

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low. US cuts to African university funding reduce

available research money even further.

Education and STEM skills You cannot innovate without scientists and
engineers. The quality and quantity of technical
education determines how much innovation a
country can produce. SA's STEM pipeline is weak —
poor school maths outcomes limit the number of
people who can enter technical fields.

Patent laws and IP protection Without patents, competitors copy new products
immediately and the inventor earns nothing. No
reward = no investment in R&D. Africa has weaker
patent enforcement — companies prefer to be users
of technology, not producers.

Competition Competitive markets force firms to innovate to

survive. Monopolies (like Eskom had in electricity)
face no competitive pressure — they do not
innovate. SA's concentrated markets (banking,
telecoms, retail) limit innovation pressure.

Government support Subsidies, tax breaks, and public R&D funding lower
the cost and risk of innovation. SA has the CSIR
(Council for Scientific and Industrial Research), DSI,
and NRF — but these are underfunded relative to the
scale of innovation needed.

Macroeconomic stability Firms plan R&D over years and decades — they
cannot do this when load-shedding disrupts daily
operations, inflation is high, and the rand is volatile.
Instability shortens business planning horizons and
kills long-term R&D investment.

Innovation vs imitation Advanced countries at the technology frontier must

innovate — no one is ahead to copy. Developing
countries can grow faster by imitating and adapting
existing technology (cheaper and faster). SA should
imitate now while building the foundation to
innovate later.

SECTION 7: SAVINGS, INVESTMENT, CAPITAL AND OUTPUT

This section covers the relationships between savings, investment, capital accumulation, output, and consumption.
The lecturer specifically said to revise this.

The Circular Relationship

THE GROWTH CHAIN — Write this and understand it

Saving → Investment → Capital Accumulation → Higher Output → Higher Income → More Saving

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Capital (K) determines Output (Y).

Output (Y) determines Saving (S).

Saving (S) determines Investment (I).

Investment (I) determines the change in Capital (K).

Then it starts again from the top.

Key Equations
Closed economy (no government): I = S
With government: I = S + (T - G)

If T - G > 0 (budget surplus): government adds to national saving — more funds available for investment.

If T - G < 0 (budget deficit): government is spending more than it earns — it reduces national saving and funds
available for private investment.

The Saving Rate and Output — What Happens

What changes What happens Long-run effect

Saving rate increases More saving → more investment → Output per worker reaches a
more capital per worker → higher output NEW HIGHER steady state level
per worker — permanently higher

At the new steady state New investment only replaces worn-out Growth rate returns to ZERO
capital — capital stock stops growing (without technology)

With technological progress Technology keeps shifting the production Growth continues permanently
added function upward — saving rate now determines
the GROWTH PATH, not just the
level

The Saving-Consumption Trade-off

Saving means NOT consuming today. This is an important trade-off:

• Saving rate = 0: no investment, capital runs down, output falls, eventually nothing to consume.
• Saving rate = 1: all income saved, maximum capital and output, but consumption = 0 (you save everything
and consume nothing).
• The optimal saving rate (Golden Rule): saves enough to maximise long-run consumption — not too much,
not too little.

SA APPLICATION — Savings and Growth

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SA's household saving rate is about 0.5-1% of disposable income — one of the lowest for a middle-income
country.

Compare: China's saving rate is 35-40%. China channelled these savings into investment → decades of 9%+
growth.

SA's government runs a budget deficit (spending more than it earns) — this means government is also NOT
saving — reducing total national savings further.

Low national saving → not enough domestic funds for investment → SA relies on foreign investment which
can leave quickly when global conditions change.

When foreign investors pulled money out of SA in 2018 (political uncertainty) and 2022 (global rate hikes),
the rand fell sharply — showing the cost of depending on foreign capital.

Physical Capital vs Human Capital

Physical Capital Human Capital

Machines, factories, infrastructure, equipment Education, skills, training, experience of workers

Accumulated through investment (I) Accumulated through education and training

Faces diminishing returns Knowledge does not face the same diminishing
returns

Can be seen and measured easily Harder to measure — sometimes estimated through
wages

Important for production in the short run Increasingly important for technology-driven long-
run growth

SA needs more: electricity infrastructure, transport SA needs more: quality education, technical skills,
R&D

SECTION 8: TECHNOLOGY AND THE PRODUCTION FUNCTION

When technology (A) is added to the production function it becomes:

Y = F(K, AN) where AN = effective labour

A = the state of technology. AN = effective labour (technology multiplies the output of each worker).

If technology (A) doubles: the economy produces as much as if it had twice the number of workers. This is why
technology is so powerful — it multiplies the productive capacity of everyone in the economy.

In steady state (with technology): output per effective worker and capital per effective worker are constant. But
because A keeps growing, output per actual worker keeps growing — so the economy never stops growing.

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SECTION 9: TECHNOLOGY AND INEQUALITY

Technological innovation helps the economy grow but it also creates inequality. This is important for exam questions
that ask about the effects of technology.

How technology creates inequality South African context

Innovators and technology owners earn much higher SA's top income earners are disproportionately in
incomes than workers technology and finance sectors

New technology allows firms to produce MORE with Automation of low-skill jobs in mining and
FEWER workers — reducing the wage bill manufacturing has displaced workers

The share of income going to the top 1% increases as SA's Gini coefficient (0.63) is one of the highest in the
innovation rises world — partly technology-driven

Advanced countries with labour protections see less SA has weak worker protections in informal sector —
wage inequality despite same technology exposure technology-driven displacement hits harder

SA APPLICATION — Technology and Inequality

The 4th Industrial Revolution (AI, robotics, automation) is eliminating routine jobs in call centres, mining, and
basic manufacturing.

These are exactly the jobs that South Africa's less-skilled workforce depends on — meaning technology could
increase unemployment further.

SA needs to invest in skills that complement technology (data analysis, engineering, digital literacy) rather
than compete with it.

Without this transition, technological progress will widen SA's already extreme inequality rather than reduce
it.

SECTION 10: CHINA'S GROWTH — CASE STUDY

The lecturer included China's growth story in the slides. It shows how institutional change + technology imitation +
foreign investment drove rapid growth.

Before 1978 — Central Planning After 1978 — Market Reforms

Output fell 20% from 1959-1962. 25 million died of Agricultural reform: farmers allowed to sell produce
famine. in free markets.

Output fell 10%+ from 1966-1968 again. State firms given freedom over production decisions.

Central planning = inefficient allocation of resources. Private businesses encouraged. Foreign investors
attracted with tax deals.

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Growth of output per worker: 2.5% per year. Growth of output per worker: over 9% per year since
1978.

Why China succeeded where Russia and Eastern Europe failed:

• Confucian culture: hard work, commitment, and trustworthiness built strong social institutions for market
activity.
• Central planning lasted fewer decades than in Russia — people adapted more easily to markets.
• Communist Party maintained political stability — controlled the pace of change rather than letting it
become chaotic.
• Private sector grew alongside state firms gradually — not replacing them overnight.
• Property rights guaranteed to foreign investors — they came with technology which was then transferred
to Chinese firms.

SA APPLICATION — Lessons from China

China shows that institutional quality and technology transfer from foreign investment can drive rapid
growth.

SA needs the same formula: stable institutions + attract FDI + ensure technology transfer to local firms.

SA's current investor climate (load-shedding, corruption, policy uncertainty) makes this difficult to achieve.

China's lesson: political stability and institutional trust are prerequisites for the technology adoption that
drives growth.

SECTION 11: EXAM ANSWERS — HOW TO WRITE THEM

Model Answer: Savings, Investment, Capital and Output (15 marks)

PARAGRAPH STRUCTURE FOR THIS QUESTION

Para 1: The circular relationship — savings leads to investment leads to capital leads to output leads to more
saving.

Para 2: The saving rate and the steady state — higher saving = higher level of output per worker, but growth
still stops without technology.

Para 3: The consumption trade-off — saving now costs consumption today but builds future growth.

Para 4: SA application — low saving rate, budget deficit, dependence on foreign capital, comparison with
China.

Paragraph 1 — The relationship:

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Savings, investment, capital accumulation, and output are linked in a circular growth process. The portion of income
that households do not consume (savings) is channelled through the financial system into productive investment.
Investment increases the stock of capital — the machines, factories, and infrastructure that make production
possible — which raises output per worker. Higher output generates more income, enabling further saving, and the
cycle continues.

Paragraph 2 — The saving rate and steady state:

The saving rate determines how much output per worker an economy achieves in the long run. A higher saving rate
increases investment, raises capital per worker, and therefore raises output per worker. However, because of
diminishing returns to capital, each additional unit of capital adds less and less output. Eventually, new investment
only replaces worn-out capital — the capital stock stops growing and output per worker reaches a steady state.
Without technological progress, a higher saving rate creates a permanently higher LEVEL of output but does not
generate permanently higher GROWTH.

Paragraph 3 — The consumption trade-off:

Saving involves a trade-off between present and future welfare. A saving rate of zero means no investment, capital
eventually runs down, and the economy loses its productive capacity. A saving rate of one means all income is saved
— capital and output are maximised but consumption is zero. The optimal saving rate — called the Golden Rule —
balances present consumption with future investment to maximise long-run wellbeing.

Paragraph 4 — SA application:

South Africa's household saving rate of approximately 0.5-1% of disposable income is critically low. Combined with a
persistent government budget deficit — where spending exceeds tax revenue — national saving is insufficient to
fund the investment SA needs. The economy therefore relies heavily on foreign capital, which can exit quickly when
global conditions change. China's contrast is clear: a household saving rate of 35-40% funded decades of investment
and produced annual growth above 9%. For SA to break its low-growth pattern, both private saving incentives and
greater fiscal discipline are necessary to build the domestic investment base that capital accumulation and long-run
growth require.

Keywords — Use These in Every Growth Answer

KEYWORDS THAT GET MARKS

output per capita, output per worker, purchasing power parity (PPP), aggregate production function

capital accumulation, diminishing returns to capital, steady state, saving rate, investment

technological progress, effective labour, human capital, physical capital

endogenous growth, exogenous technology, R&D, innovation, imitation, technology frontier

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 ECO37W1 | Macro Growth Notes | Exam Ready

dependency ratio, demographic dividend, brain drain, skills mismatch

Dutch Disease, resource curse, institutional quality, property rights, rule of law

Golden Rule saving rate, consumption trade-off, budget deficit, national saving

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