What are the sources of GDP growth, and of GDP differences across countries?

Supply-side approach to GDP presented in lecture 1, with GDP given as \(Y_t = A_t K_t^{\alpha} L_t^{1-\alpha},\) implies that growth in GDP may arise from technology, capital, or population.

Population is not that interesting from an economist’s point of view, since the object of interest for an economist usually is GDP per capita. However, population is very important for discussions of relative economic or military power, which ultimately also impact the economy.

In this lecture, we study the Solow (1956) / Swan model of economic growth, which deals with the problem of capital accumulation.

Solow (1956) emphasized the importance of capital accumulation.

He built what is now referred to as the neoclassical growth model.

Production requires that some people forgo consumption for later, which allows to build machines, and railroads, and increases the capital stock.

One long-standing question in the economics literature however is whether there can be too much savings. (that is, is any amount of savings going to be demanded by the private sector?)

After the war, important discussions were held around the substitutability between capital and labor:

• According to Keynesian economists, the growth process was basically unstable, because there wasn’t much substitutability between capital and labor. As a consequence, capital would quickly fall into diminishing returns, and “too much saving” would result in stagnant growth.

• According to neoclassical economists (including Solow), the growth process was stable, as there would always be enough demand to capital to absorb excess savings.

While we look at the data on the capital stock, and investment, keep thinking about whether you can increase production by just adding capital; and keep thinking about the substitutability between capital and labor.

The Solow (1956) growth model is very stylized (some would say, too stylized): it only has one type of capital.

In practice, depreciation is very different for different types of capital. Some examples:

• Office and accounting equipment, after 1978: 31.2%.

• Office buildings: 2.5%.

Here you can find 6 pages of BEA’s depreciation estimates for different types of capital. (needless to say, this is not exam material…)