The Standard of Living over Time

and Across Countries

Learning objective
After studying this chapter, you should be able to:
• Understand why the standard of living varies across countries
• Understand why labor productivity varies across countries
Factors affecting the Economic Growth
Factors affecting the Economic Growth
Why Growth Rates Differ Across Countries?

Because of differences in

Buildings, Transportation and

Capital Stock Communication Networks, Machines
Economic Policy

Labor input Health and education of working populations, Productivity

their productive skills

Knowledge on how to combine inputs in

Technology production; formula, design, software and
management
Factors affecting the Economic Growth
Productivity: Its Role and Determinants

• Productivity is an important factor in deciding living • The inputs used to produce goods and services are called
conditions in all countries. the factors of production.
• Productivity is directly determined by the factors of
• Productivity refers to the quantity of goods and services production.
that a worker can produce in an hour's work.
• The Factors of Production:
• Productivity is important to understand the large • Physical capital
differences in living standards across countries. • Human capital
• Natural resources
• Technological knowledge
Productivity: Its role and determinant The Transmission Mechanism
Physical Capital Per Worker
Human Capital Per Worker
• The stock of equipment and structures used to produce
• Human capital (H):
g&s is called [physical] capital, denoted K.
the knowledge and skills workers acquire through
• Capital: machines, equipment, etc.
education, training, and experience
• K/L = capital per worker.
• H/L = the average worker’s human capital
• Productivity is higher when the average worker has more
• Productivity is higher when the average worker has more
capital → an increase in K/L causes an increase in Y/L
human capital (education, skills, etc.). → i.e., an increase in
(productivity)
H/L causes an increase in Y/L

Technological knowledge:
Natural Resources Per Worker
• Natural resources (N): the inputs into production that Technological knowledge: society’s understanding of the best
nature provides, e.g., land, mineral deposits ways to produce g&s
• Other things equal, more N allows a country to produce
• Technological progress does not only mean a faster
more Y.
computer, a higher-definition TV, or a smaller cell phone.
• In per-worker terms, an increase in N/L causes an increase
in Y/L. • It means any advance in knowledge that boosts
• Some countries are rich because they have abundant productivity (allows society to get more output from its
natural resources (e.g., Saudi Arabia has lots of oil). resources).
• But countries need not have much N to be rich
(e.g., Japan imports the N it needs).

The Production Function

Challenges To Using Real GDP Per Capita
Challenges To Using Real GDP Per Capita

Real GDP per capita is not a perfect measure of the standard of living but it is the best
measure that economists have.

There are several challenges to using real GDP per capita as a measure
of the standard of living:
▪ Happiness
▪ Distribution of income
▪ Value of leisure time
▪ Life expectancy
Challenges To Using Real GDP Per Capita

Why Do We Care?

▪ We care about real GPD percapita= income of hh in average

▪ Looking across time, we want to know by how much the
standard of living has increased.
▪ The reason we ultimately care about the standard of living is
presumably that we care about happiness.

𝒉𝒊𝒈𝒉𝒆𝒓 real GPD percapita ≡ 𝒉𝒊𝒈𝒉𝒆𝒓 𝒔𝒕𝒂𝒏𝒅𝒂𝒓𝒅 𝒐𝒇 𝒍𝒊𝒗𝒊𝒏𝒈 ≡ 𝒈𝒓𝒆𝒂𝒕𝒆𝒓 𝒉𝒂𝒑𝒑𝒊𝒏𝒆𝒔𝒔

Challenges To Using Real GDP Per Capita

Real GDP per capita is not a perfect measure of the standard of living but it is the best
measure that economists have.

There are several challenges to using real GDP per capita as a measure of the standard of living:

▪ Happiness Economic Growth and Life Satisfaction

Does economic growth increase

happiness?
The Easterlin paradox: The lack of
correlation between income and
happiness across countries
The average person in a rich country
was apparently no happier than the
average person in a poor country
Challenges To Using Real GDP Per Capita

Real GDP per capita is not a perfect measure of the standard of living but it is the best
measure that economists have.

There are several challenges to using real GDP per capita as a measure of the standard of living:

▪ Distribution of income
Income Distribution and Real GDP per Capita

Real GDP per capita tells you what the average person in the economy can consume. However,
an average can be misleading because it does not tell us about the distribution of income.
Challenges To Using Real GDP Per Capita

Real GDP per capita is not a perfect measure of the standard of living but it is the best
measure that economists have.

There are several challenges to using real GDP per capita as a measure of the standard of living:

▪ Value of leisure time

Because real GDP per capita measures the
income of the average person in a country, it
tells us how many goods and services the
average person can consume.
But people care about more than the goods
and services they can purchase.

Higher income (GDP percapita) tends to have less

leisure time → thus, they value more on leisure time
Annual Average Hours Worked per Worker in High-
Income Countries, 1870–2000

Work-life balance?
Challenges To Using Real GDP Per Capita
There are several challenges to using real GDP per capita as a measure of the standard of living:

▪ Life Expectancy

Some people have argued that economic growth reduces

the quality of life by generating pollution and increasing
the stress workers feel.

Figure 3.2
Higher national income (as measured by GDP
per capita) is generally associated with higher
life expectancy at birth, although the relationship is
less pronounced at the highest levels of national income
(Figure 3.2). There are also notable differences in life
expectancy between countries with similar income per
capita. For example, Japan and Spain have higher, and
Luxembourg, the United States and the Russian Federation
lower, life expectancies than would be predicted by their
GDP per capita alone
Challenges To Using Real GDP Per Capita
There are several challenges to using real GDP per capita as a measure of the standard of living:

▪ Life Expectancy
Some people have argued that economic growth reduces
the quality of life by generating pollution and increasing
the stress workers feel.

Figure 3.3 shows the relationship between life expectancy

at birth and health spending per capita across OECD,
candidate and partner countries. Higher health
spending per capita is generally associated with
higher life expectancy at birth, although this
relationship tends to be less pronounced in countries with
the highest health spending per capita. Japan, Spain and
Korea stand out as having relatively high life expectancies,
and the United States and the Russian Federation
relatively low life expectancies, given their levels of health
spending.
Economic Growth and Public Policy
Economic Growth and Public Policy

• Government can do interventions to increase the productivity level

and the living standards by:
• Encourage people to save and invest.
• Encourage foreign investment.
• Encourage people to learn and train. → education
• Maintain political stability while establishing secure property rights.
• Encourage and support research and development.
• Investing more current resources in capital production is one way to
boost future productivity.
Economic Growth and Public Policy

Education
• Education is just as vital as physical capital investments for a country's long-
term development.
• Every year of schooling increases a person's income by around 10% on
average in the United States. As a result, providing schools and encouraging
people to use them is one way the government can improve people's living
standards.
• An educated person may come up with new ideas about how to
manufacture products and services, which may then be added to society's
pool of information and help others.
• The brain drain, or the emigration of many of the most highly trained
workers to rich countries, is an issue that some developing countries are
facing.
Economic Growth and Public Policy

Health and Nutrition

• Healthier workers are more productive. Spending more to health
care expenditure is also investing more in human capital.
• Virtuous circle: Policies that encourages rapid economic growth
would generally improve health outcomes, which would in turn
promote economic growth.
• Vicious circle in poor countries: Poor countries suffer because their
citizens are in poor health condition. People cannot afford better
healthcare and nutrition, so their populations are unhealthy.
Economic Growth and Public Policy

Health and Nutrition

• Healthier workers are more productive. Spending more to health
care expenditure is also investing more in human capital.
• Virtuous circle: Policies that encourages rapid economic growth
would generally improve health outcomes, which would in turn
promote economic growth.
• Vicious circle in poor countries: Poor countries suffer because their
citizens are in poor health condition. People cannot afford better
healthcare and nutrition, so their populations are unhealthy.
Economic Growth and Public Policy

Political Stability
• Fraud and corruption will go unpunished as well as the practice of
bribing government officials for permits.
• Political instability would make it impossible to predict whether property
rights will be safeguarded in the future.
• When people afraid of the corrupt government confiscated their capital or
being stolen by criminals, this will reduce investment from both domestic
and abroad. This will make the economy less efficient and subsequently
reduce the living standards.
• In order to create economic a growing, stable, and efficient, one need to
enforce the law, have effective courts, stable constitution, and honest
government officials.
Economic Growth and Public Policy

Research and Development

• The advancement in technological knowledge has resulted in higher
living standards. Private research by companies and individual
inventors is responsible for the majority of technical advancement.
• Government can promote the creation of new technologies via
research grants, tax incentives, and the patent system.
Economic Growth and Public Policy
Population Growth
Population Growth may affect living standards in 3 different ways:
1. Stretching natural resources 2. Diluting the capital stock 3. Promoting technological progress
• Bigger population = higher L = lower • More people
• 200 years ago, Malthus argued that
K/L = more scientists, inventors,
pop. growth would hinder society’s
ability to provide for itself. → tidak ada
= lower productivity & living engineers
PEB.
standards. = more frequent discoveries
• Fact: the world population has • Countries with fast pop. growth tend to = faster tech. progress &
increased sixfold and the living standard have lower educational attainment. economic growth
on average are much higher.
• Policy to control population growth. • Evidence from Michael Kremer:
• Malthus failed to account for Over the course of human history,
a. China’s one child per family laws
technological progress and productivity • growth rates increased as the
(KB) world’s population increased
growth
b. Contraception education • more populated regions grew
• Sretching natural resources terjadi jika faster than
technological progress dan productivity c. Promote female literacy to raise less populated ones
tidak ada atau bahkan menurun . Jadi opportunity cost of having babies
kenaikan populasi akan menyebabkan
stretching of natural reseources apabila
tidak ada tech. progress.
Conclusion
Conclusion

• Global economic growth, as measured by real GDP per human, varies

widely.
• The world's wealthiest countries have an average income that is more
than ten times that of the world's poorest countries.
• The capacity of an economy to manufacture goods and services
determines its standard of living.
• The amount of physical capital, human capital, natural resources, and
technical skills available to workers determines productivity.
Conclusion

• Government policies may have a variety of effects on the economy's

growth rate.
• The accumulation of capital is subject to diminishing returns. Higher
saving leads to higher growth for a while due to diminishing returns,
but growth will inevitably slow down.
• The return on capital is particularly high in poor countries due to
diminishing returns.