Review Of Worlds Economics Growth

1. Introduction

The world has seen unprecedented growth in the past few decades. But has everyone been benefited from this growth, or has it been only for few big economies at the cost of others? How various economies across the globe have evolved, relative to the giants, the ones which make the economic frontier and what have been the factors accounting for this growth?  How has history moulded itself into the present and what can be projected from it about the future is the central topic? The article gathers and updates a plethora of facts, evidence and theories proposed over a long period of time to get the entire spectrum of the world's economic growth and development.

First things first. Is reading the historical review of economic development even worth our time? This has been answered by (Nunn), who established the fact that literature does matter in determining current economic development. His study documented wide literature which shows the effect of historic events on long term economic development. However, the question, "how does history effect?", in order words, the channels of causality through which it matters still remain unanswered in his paper. (D Acemoglu; Dell; Huillery; Iyer) are studying and analyzing data at micro levels to identify the causal factors and precise mechanisms, but still much remains to be done. 

Meanwhile, various other studies have analyzed historical data to come up with an appropriate model of economic growth.  (Kaldor) postulated a growth model which relates the origin of technical progress to capital accumulation. Other neo-classical models of the time considered technical progress as exogenous (Wulwick).  (Jones & Romer) collected 50 years of facts, updated it and showed the development of the past five decades.  (C. J. Jones) further updated the results & facts of economic growth from the past 100 years till the latest data were available to him. Now this article additionally updates the results, incorporating all the facts and data together at one place, so as to enable the reader to understand the contrasting results from the past with the present. 

2.    Growth of Economic Frontier

Past few centuries have witnessed an exponential rise in the growth. The US has been rising at about 2% for the past 150 years. Although this digit might seem insignificant to some, (especially to south-east Asians, who are nearing double-digit growth) but  when this sustained growth is compounded for such a large period, it results in what all of us can witness today i.e. increased standards of living, by a factor of 200 (for the US). Although the US economy had glorious periods like the post-war era, flourishing dot com market and the IT sector development, they have also fallen into big pits like the great recession and the subprime crisis. Despite all this, the US grew at 2.55 percent from 1995-2001, however, from 2001-2007 its growth has only been at 1.72 percent, which is an issue of concern. Had they been growing at the same old 2.55 percent, they would have doubled their living standards in about 25 years, but at present growth rates it would take 40 years to do so. This change in the growth of their living standards against their expectations has forced them to search for scapegoats and has resulted in the decisions which the entire world witnesses today.

How can we explain the accelerated growth and how can the US or any country for that matter bring back its growth? Various models (Galor & Weil; Kremer; Romer; Lee; Lucas; Solow) have been developed to understand the economic growth in past and thereby determine the correct factors that will lead to growth in future. The baseline model, however by some economists, is still being considered that of Solow. Although it is said to be having a pessimistic view on economic growth, since it questions any measures other than technical changes to have a profound effect on the economy, his model has proven to be the underpinnings of the economic models developed later.

One such model was given by (Mankiw, Romer and Weil), who incorporated human capital into the Solow model and can be described by the equation given below:

Y = A_tM_t K_t^αH_t^β          (1)

where, Y : output, K_t is physical capital, H_t : human capital, A_tM_t : total factor productivity (TFP)

This model shows significantly larger effects of investments in physical and human capital on growth since the values calculated and given for α & β are higher as opposed to the Solow model.

Looking back at equation(1), we have three major macroeconomic variables responsible for economic growth. With the hope that these variables would be able to explain the questions raised in the beginning, we will look at each of those variables.

Capital to output ratio, which is one of the input variables of the model have contributed nothing to growth. Data shows that the investments in physical capital fell drastically after great depression and have remained almost constant since then. Although the prices of structures have increased & investments in structures have been about three times that in equipment, but the past few decades have witnessed a large fall in equipment prices  which seem to have offset the rise in real capital investment in structures (Greenwood, Hercowitz and Krussel).

Human capital, the distinguishing variable of (Mankiw, Romer and Weil) model, is the one which helps in reducing the rate of diminishing returns and provides a positive outlook for economic growth. Unlike physical capital, it appreciates with time since the experience and the education attained adds as the skill of an individual. The results provided by (Katz and Murphy) supports the same, as they observed that despite the continuous increase in the supply of college graduates, their wage premium kept on rising.  (Krusell, Ohanin and Rios-Rull) considered a setting in which equipment capital is complementary to skilled labour.

The third variable considered in the model is technological progress. (Abramovitz, Solow) showed that this factor has contributed to 80 percent of the growth in the period 1948-2013. But where does technical progress come from? Solow assumes an exogenous origin for the same. However,  (Romer) argued that technical progress results from ideas, which results from the minds of curious people, therefore being “endogenous”. A Large share of technology has come from “learning & doing”, that is, R&D. Although the small fraction of the population has been engaged in research work, it has been growing steadily across the world. This research transforms into patents, which can be straightly correlated with technical progress. After having looked at the exponential rise in the number of patents, which is considered as an output of ideas, it may be said that technical progress has an endogenous origin. For this contribution, (Romer) was awarded the 2018 Nobel Prize in Economics. (Kortum) developed a growth model based on the fact that patents can be thought of as proportionate investments in productivity. However, his model breaks after 1980 or so. (C. J. Jones, Sources of US economic growth in a world of ideas) suggested that the rise in educational attainment and investment in R&D has led to this rising long term trend of growth in the economy. On the other hand,  (C. J. Jones, R&D based models of economic growth) showed from the post-war evidence of OECD countries, that they do not support the prediction of many R&D based models.

However, mere technical progress will not translate into growth, but it also depends on the level of efficiency with which that technology is being utilized. (Banerjee and Duflo; Chari, Kehoe and McGrattan) and others have shown the effect of misallocation on total factor productivity. It was observed that the economy where resource distribution is efficient works at the frontier, otherwise inside the frontier. Therefore, there is a reduction in total factor productivity as a result of misallocation.  (Hsieh, Moretti and Hurst) showed the consequences of efficient distribution of occupation in the US between 1960-2008, that led to 15-20 percent growth in aggregate output per worker.

The growth of the country cannot be accounted for by simply looking at its GDP figures. There are many other factors which need to be included in order to bring different economies on the same page. For example, GDP per capita for Western Europe has stabled at around 75 percent level to the US, however, when other factors like health, education, life expectancy etc. are included, they look much closure to the US.

Risen standards of living amongst the population of the economic frontier can be observed by looking at the change in structural composition, increased health care expenditures and decreased work hours. It was observed that growth had a dramatic effect on structural changes. For example, employment in the agricultural sector reduced from 65 percent in 1840 to 2.4 percent in 2000 in the US and for Japan it declined from 85 percent down to about 3 percent. Health sector witnessed a large growth, with US health share increasing three folds after 1960.  (Hall and Jones) proposed that the rise in the health sector is a byproduct of economic growth. Technological advancements and rising expenditures have led to a rise in average life expectancy. However, increased per capita income leads to a decrease in the marginal utility of consumption, therefore, people tilt towards other factors than mere income for maximizing their utility. The decrement in annual work hours (as per the data from Total Economy Database of the conference board suggests) in advanced countries supports this argument. Another factor that supports the argument is the declined fertility rates, which was explained by saying that children themselves are time intensive, in which case conserving on children also conserves on time as people get richer. However, economic growth has not transformed into growth for everyone. Large disparities have emerged. (Piketty; Saez) discusses the widened gap of GDP per person for the top 0.1 percent & bottom 99.9 percent.

3.    Growth of other’s relative to the frontier

This section focuses on the growth of other economies relative to the economic frontier. It looks at how growth has distributed itself and thereby transformed countries across the globe.

Economic growth over the long run has been uneven and it occurred at different places at different points in time. For example, GDP per person in Argentina was greater than that in China and Japan in 1870s, while Japan boomed and crossed them after World War 2. (Pomeranz; Piketty; Maddison) referred to this behaviour as the “Great Divergence”. The order of unevenness in growth is self-evident from the results provided by various authors, one of them who calculated the ratio of richest to the poorest country. It was 5 in 1300, which later became 10 by 1870 (for the United Kingdom) & over 100 by 2010 (for US)  (C. J. Jones, The facts of economic growth). GDP per person for 5^th richest to 5^th poorest countries also showed widening behaviour in relative incomes after the 1960s.

However, when GDP per person relative to the US for the period 1960-2011 for 100 countries were analyzed, it was observed that the middle-income countries were growing faster and were more likely to move closer to the US, while the opposite was observed for the poor countries. Among OECD countries, those who were poor grew at a faster rate than those who were already rich. Thus a “catchup” behaviour was observed (DeLong; Baumol). (R. E. Lucas) suggested that the Great Divergence of the last 200 years may turn into the Great Convergence in the upcoming time. However, this convergence was not observed when the world was viewed as a whole. (Barro; Sala-i-Martin; Mankiw, Romer and Weil) explained this behaviour by saying that the countries around the world were converging, but to their own steady states. Their steady-state levels were determined by factors like investment rates in physical capital & human capital etc.

One of the major reason behind this spread is the differences in the total factor productivity (TFP). For the poorest countries, TFP accounts for over 80 percent of the GDP per capita difference, however, for richest countries, it accounts for about 50 percent of the differences. These differences in TFP were said to be caused due to “measure of our ignorance” or uncertainties in input measurements and “misallocations” or the inefficiency of utilization.

It has been long conjectured that there lies a big role of institutions in determining long-term economic growth.  (Olson) observed that history itself provides us with natural experiments to study the impact of the institutions on the economies and supported the previous argument. Many other studies have been dedicated to showing the same. One of the interesting study conducted by (Acemoglu, Johnson and Robinson, Reversal of fortune: geography & institutions in the making of the modern world income distribution) observed “reversal of fortune” in European colonies. Those countries that were rich 500 years ago, measured by urbanization, are on average or poor conditions today. The explanation provided was that the people in the successful countries set up “extractive institutions” (C. J. Jones, The facts of economic growth) that is, they migrated to places that were sparsely populated and setting up newer institution at those places leading to their growth. These studies show the importance of strong & transparent institutions on the economy. Along with this, it was observed that government’s involvement through taxes has large impact on the economy too. Counter-intuitively, the co-relation between tax revenue as a percentage of GDP and economic success was found out to be positive.

4.    Conclusion

The World has grown large and big, pockets have become deep and life’s easier. It seems to be true when looked broadly, but at the ground level, it is not the case. Growth has accelerated and standards of living have risen but of few and not the globe. The inequality gap has widened so much that those few have now started to dominate the observable statistics of the world. The article has shown a variety of facts for you, yourself to look into and realize the same, but there still are perspectives which needs to be looked through to come to the final conclusion, like including the effect of globalization, open trade, the effect on environment and much more. 

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