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Long run Macroeconomics

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Abstract

Long term is what really matters for economists. It is not enough a decade of continuous growth if an economy does not have adequate policies to perpetuate that growth. So, the models in general in macroeconomics are about the long term. As mentioned in other articles, the economy fluctuates permanently along a trend and it is normal to present crisis in certain periods of time. But to ensure production growth constantly over time, government policies must focus on variables such as savings rate, capital accumulation, human capital development among others that offer the ability to maintain stable growth.

In the long term of the economy, the interannual fluctuations of economic activity predominate. When recessions happen, causes consumers to be pessimistic and when the economy is expanding, consumers are optimistic and their behaviors demonstrate. But if you look to the past in long periods of time the panorama changes, and fluctuations are not important but the long-term growth is. What matters, in the long run, is the historical aggregate production, so the objective of this branch of macroeconomics is to determine which factors affect long-term growth, why some countries grow more than others and why there are more inequalities between countries. In the following graph, you can see the growth of some countries.

GDP PER CAPITA

Graph 1 GDP PER CAPITA. Data taken from the World Bank.

The reason why growth is important is that this determines the standard of living and determines whether it has improved this in time. Because of this, what matters to macroeconomics is not only aggregate production but production per person as this approximates each person’s standard of living. Economists do not ignore the fact of inequality, but studies and models try to approach reality so it is necessary to have these variables that even though they are not entirely true, they approximate to reality. At this point, there are several variables that try to measure the quality of life of people as their consumption, necessities unmet, among others, which measure the overall well-being

When you compare production per person you should adjust by purchasing power parity, in other words, the prices are adjusted in real terms to be able to compare a basket of goods that can be bought in each country, otherwise, these indicators would be affected by exchange rates. One of the great conclusions that can be seen after seeing the growth of different countries is that in general welfare in all countries has increased and in some countries, growths have converged at similar rates, but there are others in which the Growth seems to have stagnated as in Africa and some countries in South America

To analyze growth in countries, economists have used long-term models, initiated by Robert Solow at the beginning of 1950. The models consider aggregate production and try to have variables that affect production such as capital and workers in an economy. The way in which these two factors are related to the models is affected by technology, as an economy with a higher technology will be more efficient with the factors it has and thus will reach greater aggregate production. With such simplified models, graphics are very similar to reality, and it is also concluded that growth rates stop increasing in certain periods of time and by the characteristic of declining yields. What indicates declining yields of the factors is that the larger the accumulation of these factors, they cease to be so productive because the economy is saturated with these and are no longer as necessary as in the beginning.

With these concepts clear it is valid to ask yourself the question why an economy grows and which factors promote the growth. With long-term macroeconomic models, it is concluded that increases in worker output are due to increases in capital per worker, technological improvements or more skilled workers. The education is a very interesting explanation because it explains the great growth after the Second World War as technological innovations made production more efficient in all countries and the knowledge of people also had an expansion during this period. In conclusion, what determines long-term production is the relationship between production and capital as the amount of capital determines production. In graph 2, the gross capital formation is a variable of physical capital.

Gross capital formation

Graph 2 Gross capital formation. Data taken from the World Bank

Another important aspect of the long-term growth of economies is the saving rate of each economy. It has been seen in data that the most saving economies grow more in the long run and an example of this are the Asian economies that have high savings rates and thus grow more than the average of countries. Similarly, technological progress helps to grow constantly more than in the past. But here arises another concern, what determines the rate of technological progress? The answer is the projects that are carried out in an economy and the way the economy is organized, its rules and the institutions.

Governments can influence the saving rate in various ways. In the first place, they can change public savings, in other words, to have a surplus in the government budget. Moreover, governments can use taxes to influence private savings, for example, they can grant tax privileges to people who save to make more beneficial the saving. But at this point arises a problem and is that consumption suffers when there are higher rates of savings and the desire of an economy that grows is that people consume more so there should be a limit on savings rates because an economy with excessively high rates is also not ideal for economists. But if you take an economy with zero savings to invest in capital, the economy will have zero capital and consumption will also have the same value, so it is better than the saving rate is positive but not excessive as consumption will also be null and that is not the ideal of the economy. In graph 3, a gross saving rate can be observed in which the most developed countries are the ones with the highest savings rates.

Gross savings

Graph 3 Gross savings. Data taken from the World Bank

There is empirical evidence that most countries are below the optimum savings level and are therefore below their optimal capital level and their consumption is not the maximum they could get. But the savings rates that are considered in these initial models are only used to acquire physical capital, but as mentioned previously, economies have another capital that is also very important which is human capital. An economy that has many skilled workers will be much more productive than another that does not have the same types of workers. Human capital has increased as much as physical capital in the last two centuries. It is known that at the beginning of the first Industrial Revolution, 30% of the workers knew how to read and now that percentage is located at 95%. Graph 4 shows the difference in the rates of children enrolled in tertiary education.

Gross enrolment ratio

Graph 4 Gross enrolment ratio. Data taken from the World Bank

After having introduced the distinction within the capital of an economy it can be concluded that the level of production of an economy depends on physical capital, human capital, and technology present in an economy. An increase in the physical capital per worker and an increase in the average level of qualifications per worker would lead to an increase in production per worker. A problem is that the population today is so educated and the yields of this are also decreasing the most children now know how to read, write and have the possibility of going to college so it is no longer so representative the education as it was in the last century. Savings also influence human capital as an increase in savings in this capital increases production per worker.

Considering another important variable in long-term growth the technological progress will be exposed. Technological progress helps economic growth at least in the short term because it makes the economy more efficient and allows new objects to be produced at higher speeds. But it is not a permanent effect because after the economy is accustomed to these innovations, its effect on growth disappears. Technological progress reduces the number of workers needed to achieve a certain amount of production, in other words, it allows to produce more without having to increase the factors already exposed.

Technological progress has made great strides throughout history from finding sources of energy to the understanding of the human body. In modern economies, most of the technological progress comes from investment in research and development, which is commonly denoted (R&D). According to some estimates, countries allocate between 3% and 5% of GDP and modern companies allocate large resources to this in order to be at the forefront of the market. For a company to have incentives to invest in research and development there must be clear rules such as proprietary rights and patents that guarantee companies to receive returns on investment in R&D. In Figure 5, the difference in research between countries can be seen.

Researchers in R&D

Graph 5 Researchers in R&D. Data taken from the World Bank.

There is data showing that the recorded growth from 1950 to the present has been generated by the technological process rather than the accumulation of physical capital, but without the latter being negligible for economic growth. Throughout history it has been seen that the poorest countries have less physical capital initially but then converge their growth rates with the most developed because they implement the technological progress of the most advanced countries, in other words, they take advantage of the progress of developed countries and as the technological levels converge, the production per worker is also converging. This is one of the central ideas about technological progress, as the most advanced countries are on the technological frontier and must innovate more, while lagging countries can mimic the technology of the advanced countries and close the gap between them without having to innovate. While this occurs in some countries, not all are able to do so due to inefficient policies and institutions.

 

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