Deck 4: Long-Run Economic Growth

Question 1

Go to FRED (the Federal Reserve Economic Database) table "Purchasing Power Parity Converted GDP Per Capita Relative to the United States, average GEKS-CPDW, at current prices for China" (http://research.stlouisfed.org/fred2/series/PGD2U2CNA621NUPN). Update and explain the graph found here and in the chapter.

Answer 1

We note that the table only goes through 2010. No problem-we have a solution for that:
Growth of this ratio (PPP per Capita China GDP)/(PPP per Capita GDP USA) approximately equals
Growth of (PPP per Capita China GDP) - Growth of (PPP per Capita GDP USA) or
Now (2014) per capita income is about 25 percent of that of the United States. See below:
* Differs from chart 2010 figure of 21.5 percent due to GDP revisions since chart was published.
From Penn Tables ( HYPERLINK "https://pwt.sas.upenn.edu/Documentation/append61.pdf" https://pwt.sas.upenn.edu/Documentation/append61.pdf), which is an attempt to estimate the U.S. dollar value of every good in China (importantly: what the actual dollar price would be of services in China but if those services could be sold in the United States). So PPP here is defined more broadly to include all goods (traded plus non-traded), which is a different definition from the PPP exchange rate, which generally only applies to traded goods. Or to quote Appendix 61 of the Penn tables:

Question 2

Explain using the Solow framework why China's economic growth will inevitably slow in the coming years. Pay particular attention to what factors "drag a country" down to the slower growth steady state.

Answer 2

As China moves along the curve below in a rightward direction, three factors kick in:
i. Diminishing returns.
ii. Depreciation on an ever-larger capital stock takes up a larger share of national savings.
iii. Each new birth requires ever more capital also absorbing more savings.
These factors, then, tend to slow an economy in terms of output. They are related to a key constraint in any economy: the growth of a key input, the labor force. Short of technological progress, labor force growth will act as a bottleneck which slows GDP growth to the same rate as the assumed rate of growth of the population.

Question 3

Using the standard Solow framework, explain how China's one child policy of the past affects per capita incomes in the short run and the long run. Explain how it will affect economic growth in the long run.

Answer 3

In fact the one child policy has had two related effects: slower labor force growth and an aging population. Both act as constraints to economic growth in the long run in a Solow framework where labor force growth determines steady-state (long run) growth.
Recall, in the steady state:
where η is population growth. The aging population has another effect-it increases the dependency ratio which in turn is a force that would lower national savings. This will also have a negative impact on long run per capita income. In the short run and the long run, the one child policy shifts the uses line down and to the right (see below)-this has the effect of increasing per capita income. Since the uses line is everywhere lower than before: Sources (Savings) - Uses (Pop. growth + Depreciation) is higher in the short run implying faster accumulation of capital and higher short run per capita incomes in the transition (in the earlier years of the short run).

Question 4

Urban residents from one child families can now have two children in China. Discuss this policy and how it will affect the growth of the labor force in China in the coming years à la Solow.

Question 5

Using the World Bank estimates in Table 4.1(in the text) and the estimates for 1978-98 in Table 4.3(in the text) provide an estimate for the Solow alpha and beta we discuss in the growth accounting equations in the chapter.

Question 6

Linking the Solow framework with real returns on capital.
a. Using the Solow framework, explain why faster population growth would increase the real returns to capital in the long run steady state.
b. At China's current stage of development, what are the factors that make its returns to capital so much higher than that of a mature economy such as the United States?

Question 7

Utilizing the Solow growth framework:
a. Explain the sources of economic growth for China in the past and what the sources will be in the future using the following equation:
ΔY(t) / Y(t) = ΔA(t) / A(t) + αΔK(t) / K(t) + βΔL(t) / L(t)
b. Explain why we say that surely China's growth rate will slow in the future.
c. Explain why China's high savings rate is an unlikely source of sustainable growth.

Question 8

In as detailed a manner as possible, discuss the quality of China's growth compared to the quantity of China's growth. Use equations, facts, and data in your discussion.

Question 9

We discussed different stages of growth for economies around the world-from basic growth to advanced growth. Provide different periods in China's recent economic history which might correspond to the different phases. Include what will happen in the future. Be specific about the necessary ingredients for each stage.

Question 10

Provide the intuition behind the DuPont model of sustainable growth which specifically links the growth in GDP (sales) to a nation's return on assets. Is this consistent with what is happening in China and the United States?