KW_Macro_Ch_08_Sec_03_Why_Growth_Rates_Differ

KW_Macro_Ch_08_Sec_03_Why_Growth_Rates_Differ - chapter 8...

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>> Long-Run Economic Growth Section 3: Why Growth Rates Differ chapter 8 In 1820, according to estimates by the economic historian Angus Maddison, Mexico had somewhat higher real GDP per capita than Japan. Today, Japan has higher real GDP per capita than most European nations and Mexico is a poor country, though by no means among the poorest. The difference? Over the long run, real GDP per capita grew at 1.9% per year in Japan but at only 1.2% per year in Mexico. As this example illustrates, even small differences in growth rates have large con- sequences over the long run. But why do growth rates differ across countries and across periods of time? The simplest answer is that economies with rapid growth tend to be economies that add physical capital, increase their human capital, experience rapid technologi- cal progress, or all three, on a sustained basis. The deeper answer lies in policies and institutions that promote economic growth—policies and institutions that ensure that those who generate additions to physical or human capital, or to technological progress, are rewarded for their efforts.
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Savings and Investment Spending To increase the physical capital available to workers, an economy must engage in investment spending. There are two ways to do this. One way is for its residents to engage in saving—that is, for them to put aside some of their income rather than using it for consumption spending. Such domestic savings can be generated by private households saving some of their disposable income, by the government spending less than its tax revenues, or both. The other source of funds for investment spending is foreign savings from residents of other countries. Let’s focus first on domestic sav- ings, those generated by a country’s own residents. Both the amount of savings and the ability of an economy to direct savings into productive investment spending depend on the economy’s institutions, notably its financial system. In particular, a well-functioning banking system is very important for economic growth because in most countries it is the principal way in which sav- ings are channeled into business investment spending. If a country’s citizens trust their banks, they will place their savings in bank deposits, which the banks will then lend to their business customers. But if people don’t trust their banks, they will hoard gold or foreign currency, keeping their savings in safe deposit boxes or under the mat- tress, where it cannot be turned into productive investment spending. As we’ll discuss in Chapter 13, a well-functioning financial system requires appropriate government regulation that assures depositors that their funds are protected. Government policy has an effect on savings and investment spending in two other
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This note was uploaded on 04/10/2008 for the course ECONOMICS 103 taught by Professor Sheflin during the Spring '08 term at Rutgers.

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KW_Macro_Ch_08_Sec_03_Why_Growth_Rates_Differ - chapter 8...

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