Kindle Notes & Highlights
labour supply, which simultaneously provides consumers the income to buy new products, is the more fundamental determinant of GDP growth. Nevertheless, from a consumer demand perspective, it is also the case that rich mature economies are perhaps somewhat saturated compared to emerging economies. It is harder for them to find new products for growth, and hence this contributes to their lower growth.
the rank can have second round effects: a country with a better rank will attract more investment compared to others, which will boost its growth. Indeed, the EDB ranking is correlated with the global competitiveness index brought out by the World Economic Forum.
EDB index cannot explain cyclical fluctuations. For macroeconomic analysis, we should think of EDB as a background factor affecting the potential GDP growth over time, but not the actual GDP growth in any given year.
(i) Countries with a greater EDB rank generally have a high per capita income. (ii) At the same time, countries with a better EDB rank tend to have high per capita income and low growth. (iii) Finally, growth is higher in those economies that started from a low base and then liberalised, even though their EDB rank is low, such as China, India and other emerging economies.
well-defined property rights as captured by the EDB rank are essential for economic progress and result in a high per capita income as seen in Fig. 1.b. This is in contrast to the conventional approach in which the savings rate is seen as critical for growth. Second, however, a high per capita income leads to a reduction in labour supply that slows down growth as seen in Fig. 1.c. Third, countries with low EDB rankings have high growth, but this likely reflects the negative impact of high per capita income on labour supply, etc. Also it should be noted that the EDB rank does not affect growth
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Another very important determinant of potential GDP growth is political stability, which impacts the EDB.
strong negative correlation between the starting level of per capita income in year 1880 and the per capita growth rate from 1880 to 1988.
labour force (L) is made up of those in the working age group who are either employed (E) or unemployed (U). The unemployed are those without a job and looking for one. If they are not looking for a job, they are classified as not in the labour force (N).
Labour Productivity Tonnes/hr
Total Output = Labour Input (Total Hours) × Output per Hour (Labour Productivity)
g(Output) = g(Total Hours) + g(Labour Productivity)
g(Output) = g(Population) + g(Labour Productivity)
g(Output per Capita) = g(Labour Productivity)
increase in standard of living (output per capita) depends upon real wages, which in turn depend upon increases in productivity growth.
demographic dividend.’ The phenomenon implies a low dependency ratio, i.e., a high ratio of working age to the total population. For a given population, this leads to a higher growth in hours and, thus, in GDP growth.
Much of India’s low dependency ratio reflects a high birth rate in those backward states where labour force participation, in general, and for women in particular, is low.
in assessing potential GDP growth, for emerging economies, the focus should be on labour supply growth.
to compare across time and across economies, we should look at ratios, i.e., proportional levels of relevant variables or growth adjusted levels, e.g., the economy’s profit rate.
at a fundamental level, it should be kept in mind that the variables which affect macroeconomic welfare are ratios, not what the media and corporate sector focuses on, i.e., growth rates. The basic variables pertaining to measuring and assessing the state of the economy are: (1) Level of output (2) Growth rate (3) Adjusted for trend Output Ratio (aftOR),
aftOR = 100 × (Actual Output/Potential Output)
(4) The most crucial concept is ADSGAP = aftOR – 100, i.e., the Aggregate Demand Supply Gap.
output gap (100 – aftOR), or GDP gap,
Potential GDP generally does not follow a smooth trend. However, it is conceptually useful to start thinking about business cycles as fluctuations around an unchanging trend. An economy can be assumed to be at potential on average. The trend growth rate is thus the potential GDP growth rate.
the absolute recession need not coincide with aftOR falling below 100.
Phase Growth Rate Binary State Boom gy > gy* aftOR > 100 Slowdown 0 < gy < gy* aftOR > 100 (Usually) Recession gy < 0 aftOR < 100 Slow Recovery gy < gy* aftOR < 100 Fast Recovery gy > gy* aftOR < 100 (Usually)
The classification of a phase here, and also in the classification of the actual data, often depends on what was happening in the previous phase.
a growth recession occurs when the GDP growth is positive but below the trend or potential. Based on this definition, a growth recession implies that aftOR is falling, whatever its absolute value, although the output is rising.
The most precise indicator of the state of the economy is aftOR.
If aftOR > 100 (ADSGAP > 0) the economy is overheated. If aftOR < 100 (ADSGAP < 0) the economy is in slack
In long-run equilibrium (LRE), Actual Output = Trend Output and aftOR = 100 and ADSGAP = 0
URATE, which is given by the formula: U = U* − λ ADSGAP
URATE = 6 – 0.2 (aftOR – 100) = 6 − 0.2 (ADSGAP) In this URATE equation, the constant 6 here is the long-run equilibrium value or what is called the natural rate of unemployment (discussed in Chapter 2), corresponding to aftOR of 100. The λ coefficient linking aftOR to the unemployment rate in Table 1.F is 1/5, i.e. a 5 percentage point rise in aftOR reduces the unemployment by 1 percentage point.33 This is called the Lokun coefficient.
The term ‘Lokun’ signifies the linking Okun coefficient. As explained below, the value of this coefficient is based on cyclical changes in labour productivity, hours, etc. For analytical convenience, these changes are assumed to be the same over all ranges of output.
potential GNP will, on an average, be equal to actual GNP and fluctuate around it.
a 3% fall in GDP growth leads to a 1% rise in URATE. This rule of thumb came to be called Okun’s Law.37 The estimated coefficient mostly reflects cyclical changes in productivity, hours of work, etc.
gy = g(E) + g.
all the three variables, average hours, labour force participation rate and labour productivity, are what is called pro-cyclical. They rise during an expansion as the URATE falls, and vice versa. Firstly, hours are strongly pro-cyclical, sharply reduced by employers during a recession. Secondly, during a recession, productivity declines since existing workers and other resources are not fully utilised. This is called labour hoarding in macroeconomics and ‘benching’ in India’s Information Technology industry. Thirdly, as the economy weakens, many workers drop out of the labour force instead of
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two ways of estimating potential GDP: structural methods and time-series methods. The former are based on actual inputs of labour, capital stock and measures of technology (as in the Solow growth model) that go into output.
The simplest way to estimate the trend is to connect the first and the last points.
The drawback of all the time-series methods is that a high growth period mechanically raises estimates of potential GDP and vice versa.
even for structural estimates, periods of high growth tend to raise estimated potential GDP growth.
A recession is a period of a fall in the level of economic activity (i.e. ‘negative’ growth). If the fall in output is very steep, it is a depression,
Like an absolute recession, a growth recession will lead to a fall in aftOR, create economic slack and so raise the unemployment, lower profitability and reduce economic and business welfare. As a first approximation, a long period of growth recession can lead to a lower aftOR and, thus, to lower economic welfare than a short period of absolute recession.
When the IMF talks about the world economy being in recession, they generally refer to world GDP growth falling below 2%.
Recessions have become less severe since the service sector is less cyclical compared to manufacturing.
subsequent effects of the initial change in AD – this is the Keynesian multiplier process.
Phillips Curve, which is about the links between inflation and unemployment.
When aftOR goes up, so does employment and URATE comes down. Wages also go up as the demand for labour rises, since workers have to be paid more to be induced to work.
