Fundamentals of

Macroeconomics
Chapter II:
Growth

Michael Evers

Goethe-University Frankfurt

WS 2016/17

Fundamentals of Macroeconomics: Chapter II 1/26

 Outline

1. Introduction
2. The Solow Model
3. The Ramsey Model
4. Outlook: Endogenous Growth and Other Determinants
5. References

Fundamentals of Macroeconomics: Chapter II 2/26

 Outline

1. Some Basic Facts and the Questions

1.1 Long-Run GDP Data
1.2 Cross-Country Income Differences
1.3 Income and Welfare
1.4 Convergence
1.5 Summary

Fundamentals of Macroeconomics: Chapter II Some Basic Facts and the Questions 3/26
1.1 Long-Run GDP Data Maddison Data Set

What Explains Economic Growth?

Real GDP in 1990 Int. GK$

World
Europe
Asia
50,000,000 Africa
North America

25,000,000

10,000,000

5,000,000

500,000
1000 1100 1200 1300 1400 1500 1600 1700 1800 1900 2000
Year

Fundamentals of Macroeconomics: Chapter II Some Basic Facts and the Questions 4/26
1.1 Long-Run GDP Data Maddison Data Set

Can Economic Growth be Explained by Population

Growth?
Population in thousands

World
Europe
Asia
Africa
North America

5,000

1,000

100
1000 1100 1200 1300 1400 1500 1600 1700 1800 1900 2000
Year

Fundamentals of Macroeconomics: Chapter II Some Basic Facts and the Questions 5/26
1.1 Long-Run GDP Data Maddison Data Set

GDP per Capita Growth

Real GDP per capita in 1990 Int. GK$
60,000
Europe
Asia
Africa
North America

30,000

20,000

10,000

1,000
1850 1900 1950 2000
Year

What then explains GDP per capita growth?

Fundamentals of Macroeconomics: Chapter II Some Basic Facts and the Questions 6/26
1.1 Long-Run GDP Data Maddison Data Set

Investment Rate and GDP Growth

CYP
EGY THA
JPN
0.04
IRL PRT
ARG ESP
ISR NOR

Annual Growth Rate, 1960−2010

BRA
PAN ITALUX
0.03 AUT
FIN
NLD BELDEU
PER IND TUR FRA
GBR DNK
SWE ISL
MUS MAR CAN AUS
TTOBOL USA
0.02 PAK CHE
MEX
COL
CRI
NZL
PHL ZAF
GTM LKA URY
0.01ETH SLV
HND
NGAUGA VEN

0
KEN

−0.01

−0.02
COD
0.1 0.15 0.2 0.25 0.3 0.35 0.4
Average investment share in GDP, 1960−2010

Countries with higher investment in physical capital tend to grow

stronger

Fundamentals of Macroeconomics: Chapter II Some Basic Facts and the Questions 7/26
1.1 Long-Run GDP Data Maddison Data Set

Years of Schooling and GDP Growth

0.07 BWA
KOR
SGP
0.06
TWN

0.05
Annual Growth Rate, 1960−2010
HKG
ROU
CYP
THA
EGY CHN JPN
0.04 MLTGRC IRL
PRT
IRN MYS ESP
ARG
IDN TUN GAB ISR NOR
BRA ITA
PAN LUX
0.03 DOM
AUTFIN
LSO TUR BEL NLD DEU
IND PER FRA
MRT ECU GBRCHL DNK
ISL SWE AUS
MAR MUSPRY BOL
BRB CAN USA
0.02MOZ PAK COG
SYR COL MEX CHE
ZWE CRI NZL
MLI ZAFJOR
PHL
GTM URY FJI LKA
0.01 NPL NAM
CMR SLV
HND
UGA
MWI TZA TGO VEN
BEN
RWA
GMB BGD GHA JAM
0 BDI CIV KEN
SEN ZMB
−0.01 CAF
NER

−0.02
COD
2 4 6 8 10 12
Average years of schooling, 2010

Countries with higher investment in human capital tend to grow

stronger

Fundamentals of Macroeconomics: Chapter II Some Basic Facts and the Questions 8/26
1.1 Long-Run GDP Data Maddison Data Set

Capital Accumulation and Technology

High capital stock is associated with faster growth, but may be

driven omitted variable that affects both
In particular, efficiency with which capital is used is important:
“technology”
Capital accumulation and technology in addition to population can
be seen as proximate causes
Caveat: Correlation vs. Causation

Fundamentals of Macroeconomics: Chapter II Some Basic Facts and the Questions 9/26
1.1 Long-Run GDP Data Maddison Data Set

Growth Rates and the Natural Logarithm

In this course, we only use the natural logarithm (denoted

interchangeably ln or log)
Remember, for infinitesimally small dx:

d ln x 1 dx
= ⇒ d ln x =
dx x x
This means log differences can be approximately interpreted as
percentage changes
If variables grow at same constant rate, x1t − x2t increases, while
ln x1t − ln x2t remains constant
The Power of Compound Growth Rates: At 2 percent growth, GDP
doubles every 35 years. In 200 years, this amounts to a 52-fold
increase

Fundamentals of Macroeconomics: Chapter II Some Basic Facts and the Questions 10/26
1.1 Long-Run GDP Data Maddison Data Set

Differences in Growth Rates

Log Real GDP per capita in 1990 Int. GK$
11
Europe
10.5 Asia
Africa
North America
10

9.5

8.5

7.5

6.5

6
1850 1900 1950 2000
Year

Countries grow at different rates, but growth rates seem to be fairly

constant.
Fundamentals of Macroeconomics: Chapter II Some Basic Facts and the Questions 11/26
1.2 Cross-Country Income Differences Acemoglu (2008) Section 1.1

Distribution of World Incomes over Time

1960
1980
2000
2010

Density of countries

0 20,000 40,000 60,000

GDP per capita ($)

Mode of the distribution has increased from $1,250 to $3,200

Overall range of distribution has been increasing
Large inequality still persists
Fundamentals of Macroeconomics: Chapter II Some Basic Facts and the Questions 12/26
1.2 Cross-Country Income Differences Acemoglu (2008) Section 1.1

Log Distribution of World Incomes

1960
1980
2000
2010

Density of countries

6 8 10 12
Log GDP per capita

From 1960 to 2000: “stratification phenomenon”: some

middle-income countries have become rich while others even
regressed
Last 10 years have seen extraordinary growth, but will it persist?
Fundamentals of Macroeconomics: Chapter II Some Basic Facts and the Questions 13/26
1.2 Cross-Country Income Differences Acemoglu (2008) Section 1.1

Population-Weighted Log Distribution of World

Incomes

1960
1980
2000
Density of countries 2010

6 8 10 12
Log GDP per capita

Gives larger weight to China, India, US, Indonesia, Brasil, etc.

Fundamentals of Macroeconomics: Chapter II Some Basic Facts and the Questions 14/26
1.2 Cross-Country Income Differences Acemoglu (2008) Section 1.1

There is enormous differences across countries

Fundamentals of Macroeconomics: Chapter II Some Basic Facts and the Questions 15/26
1.2 Cross-Country Income Differences Acemoglu (2008) Section 1.1

Fundamentals of Macroeconomics: Chapter II Some Basic Facts and the Questions 16/26
1.3 Income and Welfare Acemoglu (2008) Section 1.2

Income and Welfare

Should we care about income differences?

GDP an imperfect measure of welfare or well-being:
Valuation at market price, not at social cost
Does not capture non-market activities
Disutility of labor, resource costs?
Some GDP components may be viewed as "regrettables".
But: GDP is highly correlated with other important measures of
quality of life, health, and standard of living

Fundamentals of Macroeconomics: Chapter II Some Basic Facts and the Questions 17/26
1.3 Income and Welfare Penn World Tables

Income and Consumption

QAT
LUX
11 MAC
BRN
KWT SGP
NOR
CHEUSA
NLD AUT BMU
AUS
HKG

Log Consumption per capita, 2010

IRL
DNKBEL
SWECAN
DEU
FIN
ISL GBR
FRA
JPN
OMNKOR ITA
ESP
TWN CYP
NZL
SVN
ISR GRC
10 BHR MLT
CZE PRT
SAU
HUN
EST
TTO BHSBRB
SVK
RUSPOL
HRV
LTU
GAB MYS LVA
CHL
KAZ
TUR
BLR
ATG
BGR ARG
ROULBN
KNA
MEX
TKM BWAIRNPANMNEURY
DMA
MDV LCAAZE VEN SRBCRI
MUS
THA BRA
DOM
GRD
VCT
9 GNQ CHN BLZ
PER
ZAF
ALBMKD
COLBIH
UKR
TUN
SURECU
UZB GEO JOR
BTNMNG LKA NAM
EGYJAM
ARM
PRYFJI
GTM
AGO ZWE CPV
IRQIDN
SYR
BOL SWZ
IND MAR
PHL
VNM MDA
8 TJK
HND
COG LAO YEM
MRTPAK
GHA
SDN
NGA
ZMBDJI
KHM
KGZ
TCD CMRSTP
BGDCIV LSO
SEN
GMB
KEN
BEN
TZA UGA
NPL
RWA
7 BFA
GIN
MLI
SLV
COM
TGO
GNB
SLE
MWI MOZ
MDG
ETH
CAF
NER
BDI LBR
6
COD

6 7 8 9 10
Log GDP per capita, 2010

Rich countries also consume considerably more than poor ones

Note that PPP-adjusted figures account for different price of
consumption bundles
Fundamentals of Macroeconomics: Chapter II Some Basic Facts and the Questions 18/26
1.3 Income and Welfare Penn World Tables

Income and Health

85
JPNHKG
ITA
ESP CHE
AUSSGP
ISR ISL
SWE
FRA
MLT
KOR
NZL
GRC GBRNLDNOR
CAN
AUT
IRL MAC
80 SVN
CYP
CRI CHL PRT DNK
DEU
BEL
FIN
BMU
LUX
Life Expectancy at Birth, 2010 ALBMDV CZE
USABRN QAT
MEXHRV
URY BRB
POL
SYR ECU GRDPAN
BLZ
BIH ARG EST
BHS
75 VNMLKA TUN MKDLCA
MNE
VEN
SRB
THA MYS
SVK
BHR
HUN KWT
CPVARM PER
COL
GEOCHN
JOR TUR
BGRLVA
ROU SAU
HND PRYEGY
JAM DOM
BRA
MUSIRN LTU OMN
SLV MAR VCT LBN
GTM SUR UKRAZE BLR
70 KGZ MDAIDN FJI TTO
NPLBGD PHL
IRQ
MNG RUS
KAZ
UZB
TJK
LAO BTN
MDG BOL
65 PAK
YEM IND TKM
STPGHA
KHM NAM GAB
COM SDN
60 SEN
ETH GMB MRT
TZA DJI
COG
LBR TGO KEN
BEN
55 NER
RWA
BFA CIV
GIN
MWI UGA BWA
ZAF
MLI CMRNGA GNQ
AGO
50 BDI MOZ TCD
ZWE
COD ZMB SWZ
GNB LSO
CAF SLE

45
6 7 8 9 10 11 12
Log GDP per capita, 2010

Large correlation between Life expectancy at birth and GDP

Major outliers: HIV/AIDS in sub-Saharan Africa
Fundamentals of Macroeconomics: Chapter II Some Basic Facts and the Questions 19/26
1.4 Convergence Acemoglu (2008) Section 1.5,Romer (2012), Chapter 1

Convergence

Convergence: Do measures of living standards get closer together

over time?

Two Concepts of Convergence:

1. β Convergence: Relatively poor countries grow faster.
Absolute β Convergence: Countries converge in terms of per-capita
income.
Conditional β Convergence: Countries with similar structural
characteristics converge in terms of per-capita income.
2. σ Convergence: Dispersion of per-capita income across a group
of countries declines over time.

Fundamentals of Macroeconomics: Chapter II Some Basic Facts and the Questions 20/26
1.4 Convergence Acemoglu (2008) Section 1.5,Romer (2012), Chapter 1

Barro Growth Regression: β Convergence

Barro growth regressions take the form

T
gi,t,t−1 = α log yi,t−1 + Xi,t−1 β + εi,t (1)

where
gi,t,t−1 : annual growth rate between t − 1 and t in country i
yi,t−1 : output per worker
Xi : vector of control variables with coefficient vector β
Xi is supposed to capture country specific determinants
Unconditional convergence: run (1) with β = 0
If there is no unconditional convergence, α ≥ 0

Fundamentals of Macroeconomics: Chapter II Some Basic Facts and the Questions 21/26
1.4 Convergence Acemoglu (2008) Section 1.5,Romer (2012), Chapter 1

Unconditional Convergence
ROU
KOR

0.05
TWN SGP
EGY
THA JPNCYP

Annual Growth Rate, 1960−2010

0.04
GRC
CHN ARG IRL
ESP
PRT
TUR MLT ITA
HKG
0.03 IRN
MYS FIN
AUT
IDN TUN ISR FRANOR
IND BRA BEL
NLD
PER GBR
SWE
DNK
0.02 y=0.011+0.001x
BFA BOL SYR DOM ISL
LUX
MOZ PAKMAR AUS
CHEUSA
MLI ECU CHL
JOR TTO NZL CAN
PHL LKA BRB
0.01 MWI
CMR
NGA
ZWE
COL
ZAF MEX
ETH UGA
TZA CRI
GTM URY
CIV VEN
0 KEN BGDGHA JAM

SEN ZMB
−0.01 MDG

NER
−0.02
COD
6.5 7 7.5 8 8.5 9 9.5 10 10.5 11
Log GDP per Worker, 1960

No evidence for unconditional convergence: slope not significantly

different from 0
Poorer countries have no tendency to become relatively more
prosperous
Fundamentals of Macroeconomics: Chapter II Some Basic Facts and the Questions 22/26
1.4 Convergence Acemoglu (2008) Section 1.5,Romer (2012), Chapter 1

Conditional Convergence
0.055 KOR

y=0.183−0.016x
0.05

0.045

Annual Growth Rate, 1960−2010

JPN

0.04
GRC
IRL
0.035 ESP
PRT
TUR
ITA
0.03 FIN
AUT
NOR
ISR
FRA
0.025 BEL
NLD
GBR
SWE
DNK
0.02 LUX
ISL
AUS
CHE USA
CHL
0.015 NZL
CAN

0.01 MEX
8 8.5 9 9.5 10 10.5 11
Log GDP per Worker, 1960

OECD countries share similar characteristics: Xi,t−1 T β ≈ constant

Income gap decreases by 1.6% per year
Explicitly controlling for other factors like schooling, fixed effects:
estimate increases to more than 2%
Fundamentals of Macroeconomics: Chapter II Some Basic Facts and the Questions 23/26
1.4 Convergence Acemoglu (2008) Section 1.5,Romer (2012), Chapter 1

σ Convergence: convergence of GDP per worker (or per capita) to the

same level for countries with similar structural characteristics and
similar initial GDP level (Club Convergence).

Fundamentals of Macroeconomics: Chapter II Some Basic Facts and the Questions 24/26
1.5 Summary

Summary

Real GDP per capita is growing over time.

Proximate factors for economic growth might be capital
accumulation and technology.
There is substantial heterogeneity across countries with respect to
both level of income as well as pace of growth.
Real GDP is an imperfect measure of welfare or well-being.
However, it is highly correlated with other measure of quality of
life, health, or standards of living.
No evidence of unconditional convergence in world incomes.
Some evidence for conditional convergence: gap between
countries with similar observable characteristics diminishes over
time.

Fundamentals of Macroeconomics: Chapter II Some Basic Facts and the Questions 25/26
 Bibliography I

Acemoglu, Daron (2008). Introduction to modern economic growth.

Princeton University Press.
Bolt, Jutta and Jan Luiten Van Zanden (2013). “The first update of the
Maddison project - reestimating growth before 1980”. Mimeo 4.
Maddison Project Working Paper.
Romer, David (2012). Advanced macroeconomics. 4th ed.
McGraw-Hill.

Fundamentals of Macroeconomics: Chapter II References 26/26