12.3 Economic Growth and Public Policy
12.3 a. Saving and Investment
In Marx-Schumpeter-Keynes view, investment and innovation are the two variables that drive output growth. Under this, savings adjusts passively to meet the level of investment required to hold macroeconomic equilibrium and deliver a certain growth rate of output. In the Mill-Marshall-Solow approach, that channel of causality is reversed since it is assumed that all savings is automatically invested and translated into output growth under wage-price flexibility and full employment. [25]
Example: Increased capital investment allows for more research and development in the capital structure. This expanding capital structure raises the productive efficiency of labor. As labor becomes more efficient, more goods are produced (higher GDP) and the economy grows. [26]
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Saving and Investment [27]
12.3 b. Diminishing Returns and the Catch-Up Effect
Diminishing returns: A concept in economics that if one factor of production (number of workers, for example) is increased while other factors (machines and workspace, for example) are held constant, the output per unit of the variable factor will eventually diminish. [5]
Example: A factory employs workers to manufacture its product. As long as all other factors of production stay the same, at one point, each supplementary worker generates less output than the worker before him. Thus, each worker who follows provides smaller and smaller returns. [6]
Diminishing Returns [7]
Catch-Up Effect: A theory speculating that, since poorer economies tend to grow more rapidly than wealthier economies, all economies in time will converge in terms of per capita income. [8]
Example: Countries like Singapore, Taiwan, Hong Kong etc. also known as the East Asian Tigers, are some of the cases where this theory has worked. [9]
Catch-Up Effect [10]
12.3 c. Investment from Abroad
Countries like US invest in sectors that cannot be served by the means from export from their home countries. In addition to exporting, corporations can access new customers in foreign markets by investing abroad, creating affiliates and becoming multinationals in the process. [10] Foreign investment helps countries reach their economic potential by providing capital to finance new industries and by enhancing existing industries, boosting infrastructure, productivity, and employment opportunities in the process. [11]
Example: Foreign investment fills the gap between what Australia saves and invests every year. [11]
Foreign Investments Drives Growth [12]
12.3 d. Education
Well-educated workforce have higher wages, there is a clear and strong correlation between the educational attainment and median wages. A strong foundation for economic success and shared prosperity and the ability to grow and attract high-wage employers can be built by investing in education. [13]
Example: In the US, the federal government provides overall economic stability and the state and local governments assume the primary responsibility for that education system that produces a more skilled and productive workforce; this partnership worked well for a period after World War II. [13]
Education and Economic Growth [14]
12.3 e. Health and Nutrition
Health may be not only a consequence but also a cause of high income. Healthy workers lose less time from work due to ill health and more productive when working. Childhood health can have a direct effect on cognitive development and the ability to learn as well as school attendance. In addition, because adult mortality and morbidity (sickness) can lower the prospective returns to investments in schooling, improving adult health can raise the incentives to invest in education. The third is the effect of health on savings. A longer prospective lifespan can increase the incentive to save for retirement, generating higher levels of saving and wealth, and a healthy workforce can increase the incentives for business investment. In addition, health care costs can force families to sell productive assets, forcing them into long-term poverty. [15]
Example: In 1910s and 1920s, when malaria and hookworm were eradicated from the American South, children not exposed to these diseases due to their eradication had improved incomes as adults relative to those born before eradication, controlling for normal wage gains in areas that were not infected. [15]
Health, Education and Growth [16]
12.3 f. Property Rights and Political Stability
Poor quality of property rights leads to a reallocation of resources away from taxable activities that reduces the government’s tax revenues and their ability to spend. Creating and reforming political institutions that would reduce political instability and polarization in developing countries should have an important priority in the agenda for policy reform. Such measures would not only have direct effects on the countries’ political landscape nut would also have an impact on the quality of property rights and, thus, the welfare of citizens in many developing countries. [17]
Example: In several southern African countries that have property rights over elephants, controlling all other factors, have more rapid elephant population growth than those countries that do not. Also, political instability and absence of representative governments significantly lower elephant growth rates. [18]
Importance of Property Rights [19]
12.3 g. Free Trade
Export-led demand can be an important source of growth fir developing countries however they also try to export as a growth strategy. This is outward-oriented trade. Many developing countries will regard these outward-oriented policies as too risky for their own industries and prefer to erect protectionist barriers. However, outward oriented policies help increase investments, competition and employment and also boost greater equality in income. The increased sale of exports may help raise the domestic level of production and enable the country to gain from economies of scale. [20]
Free Trade Supports Economic Growth [28]
12.3 h. Research and Development
Research and development (R&D) activities allow scientists and researchers to develop new knowledge, techniques, and technologies. As technology changes, people can produce more with either the same amount or fewer resources, thereby increasing productivity. As productivity grows, so does the economy. [23]
However, it is important to understand that innovation can be shaped by public policies. One policy is direct funding of scientific and engineering research. Another is through the tax code with measures like R&D tax incentives which allow companies to enjoy lower tax rates on profits generated through patents, research, innovation, or other creative activities. [23]
Example: It is estimated that a 1% increase in R&D expenditures leads to an average increase of 0.61% in the economic growth. [23]
Korea’s Investment in R&D Fueling its Growth [24]
12.3 i. Population Growth
On a simplistic level, the relationship between growth in population and growth in per capita income is clear. After all, per capita income equals total income divided by population. [21]
In 1798, Thomas Robert Malthus published his Essay on the Principle of Population. Malthus’s fundamental argument was that population growth will inevitably collide with diminishing returns. Diminishing returns imply that adding more labor to a fixed quantity of land increases output, but by ever smaller amounts. Eventually, Malthus concluded, increases in food production would be too small to sustain the increased number of human beings who consume that output. As the population continued to grow unchecked, the number of people would eventually outstrip the ability of the land to generate enough food. There would be an inevitable Malthusian trap, a point at which the world is no longer able to meet the food requirements of the population, and starvation becomes the primary check to population growth. One weakness of his argument is that he failed to take into account the gains in output that could be achieved through increased use of physical capital and new technologies in agriculture. [21]
Example: In 19th and 20th century, Agricultural productivity rose rapidly in the United States over the last two centuries, just the opposite of the fall in productivity expected by Malthus. Increases in the amount of capital per worker in the form of machines, improved seed, irrigation, and fertilization have made possible huge increases in agricultural output at the same time as the supply of labor was rising. [21]
Population and Growth [22]
