No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Eighteen: The “macro” view of the economy 456 this family over a generation? With 2% growth, they would see a final income of $53.5K. 2% growth would take them from poverty to lower middle class territory. Yet 3% growth takes them to $79K, and 4% to $116K! So in a generation, robust growth of 4% would take someone from the poverty line to an upper middle class standard of living. If you care about the working poor, you should be concerned about promoting economic growth! In the next section we’ll review the source of economic growth: productivity. PRODUCTIVITY Since economic growth is important for improved standards of living, how do we get it? This has been a question that is always at least in the background of economics. Recall that Adam Smith was trying to get an answer to this very question in his majestic The Wealth of Nations . The full title helps us see this: An Inquiry into the Nature and Causes of the Wealth of Nations . Smith was living at the beginning of the industrial revolution that would raise the bulk of the world’s population from base subsistence levels. He could see the initial phases and wondered why some countries were experiencing this growth while others were not. His initial conclusion was that the division of labor and associated gains from specialization drove this remarkable growth, and that the benefits of this division were limited only by the size of the market. So expanded commerce between nations helped grow the pie larger, as workers could become more and more specialized. Modern economics builds on this foundation of the institutions that lead to higher growth (open and free markets) and considers how to improve the inputs to growth, focusing on the aggregate supply function: AS = A f(L, K, H, N) = Y While there are several ways to view productivity , the most common is to consider labor productivity, defined as output per worker. Manipulation of the AS equation above can lead to (with a reasonable assumption of constant returns to scale) : Y/L = A f(1,K/L, H/L, N/L) To improve productivity, there are four inputs that we can consider (A, K/L, H/L, and N/L). Increasing any of these inputs would lead to increased productivity and ultimately higher standards of living. As we learned in chapter 9, “A” can be considered a broad view of technology (to include institutions) that enables a country to produce more with a given set of resources. To improve “A,” macroeconomists would typically endorse good institutions (rule of law, markets, etc.) and technology research. For capital per worker (K/L), human capital per worker (H/L), and natural resources per worker (N/L), economists would focus on the incentives that would bring forth more of each of