168 cHAprER5 .

Long-RunEconomicGrowth

The Financial System The role of the financial system is to help the economy allocar
resourcesby matching borrowen with lenders. When the financial systemworks well, indviduals who want to borrow to finance the accumulation of physical or human capital car:
find lenders.To theextent that firms and the governmentpayfor R&D with funds obtaino:
through the financial system,a well-functioning financial qrstem can also lead to more
investment in R&D. The financial system can also affect total factor productivity br
improving the efficiency of the economy. The financial system allocatesfunds to the ind:viduals and firms who are willing to pay the most to obtain the funds. Theseindividud.
and firms are also those whose investment projects have the best likelihood of succesi
Therefore, a good financial system ensures that resources flow to their most productirt
uses,and total factor productivity for the economy increases.As a consequence,labor piaduaiviry and the standardof living are higher.
Researchby Thorsten Beck of the World Bank, Ross Levine of the University of
Mirrnesota,and Norman Loayzaof the Central Bank of Chile has shown that the financial systemhas a significant effect on total factor productivity growth.raInterestingly,it is
not just bank that matter for econonic growth. RossLevine and SaraZervosof the Worl,j
Bank havefound that stock market liquidity alsoaffectsproductivity and capital accumulation.t5 The more liquid a stock market, the easier it is for investors to sell stock.
Investorsare more likely to purchasestocks that they know are easyto sell.As a consequence,stock prices are higher, and it is lesscostly for firms to issuenew stock to pay for
investmeritprojects.This researchtells us that the developmentof financial marketsplars
an important role in sustaining economic grorvth in both developed and developins
economies.

LearmisusSfu$ett$we
Explainthe bafanced
growthpath,
convergence,
and
long-runequilibrium.
growthn
Balanced
situationin whichthe
ratioanC
capital-labor
realCDPperhourworked
growat the samerate

The BalancedGrowth Path, Convergence,and

Long-RunEquifibrium
The steadystateis the equilibrium for the economy;however,it is an equilibrium in rvhich
the key economic quantitiessuch asthe capital-labor ratio and real GDP per hour workeci
are growing. Balanced growth occurswhen the capital-labor ratio and real GDP per hour
worked grow at the same rate. The bahncedgrowth paflr shows how real GDP per hour
worked groil's over time r+'henthe economyis in the stefv-shte and experiencingbalanceC
gro*'th.,lVe can thin-li of the balancedgrowth path a{the equilibrium time path for real
GDP per hour r+'orked.We can alsothink of eachsteadNstateashaving its own unique balancedgrorrth path. Understandingthe equilibrium time path is critical for understandine
the long-run behavior of real GDP per hour worked and real GDP.
i. i,ii",ai{i:nie tr ii'i; li*ianced {tr*vytb Fath
Figure 5.i on page I45 showsthat the gror4h ratesfor most countries havebeen roughlv
constantsince 1820,rvhich suggeststhat most of thesecountries havetypically beenon or
near their balancedgrowth paths.]ust asthe steadystateis the equilibrium for the economv
at a point ia tir:re, the balancedgrowth path is the equilibrium for the economyorcr time.
Horvever,some countries, such as |apan, appear to have been off their balancedgrowth
paths for extendedperiods of time.
The experiencesof Germanyand fapan after World War II provide a good exampleoi
how an economythat is off its balancedgrowth path eventuallyconvergesback to that path.
By the end of 'v\torldWar II, both Germany and fapan had experiencedlarge decreases
in

Ialhorstentseck,Ros Levine,and Norman Loayza,"Ijinanceand the Sourcesof Growthl'

Journalof
\iol. 58,No. l-2, October-November2000,pp. 261-300.
FinancialEconorrics,
r5Ross
"StockMarkets,Banks,and EconomicGrcwthl' AmericnnFronomic
l*vine and SaraT.ervos,
Reyiaw,Vol. 88, No. 3, )une 1998,pp. 537-558.

and Long-RunEquilibrium 769

The Balanced
GrowthPath,Convergence,

9A
Ff-

FO

Post-WorldWar Il
in
Convergence
and
Germany JaPan

$20
10

EO
6E
Ellr-

oo

-a
6E
L?

Germanyand |apan exPerienced

a largedecreasein real GDI' Per
lvVarII
capita at the end of World

g(!
rd lB

.=
.=o
ru -c

Tr
-v

due to destructionof their caPitai

stoclc Germary grerr raPidlY

o
L

o
n

irom the end of the war until

about 1960.After 1960,German,v

(L

o
o

aPPearsto havegrolfn at the

sane rateasit did Prior to
the rvat.Japangrew raPidlYfrom

(lt
o
t?

the end of the \'Varuntil the

to hi*t
mid-1970s,but it aPPears

1820

1840

1860

1BB0

1900

1920

1940

2000

1980

1960

,h.i1..upitul-labor ratios as the United Statesand its alliesbombed the factories,bridges'

:nd transportation networks in both countries.Figure 5.14showsreal GDP per capita 9ve1
::rne tbr both Germanyand ]apan.Both countriesexperienceda largedecreasein real GDP
capitaat the end oiWorldWar II, due to the destructionof their capitalstodi' However'
-r
th. war, both countries grew much more rapidly than they did before the war.
,i..,
3ermany grew rapidly from ttre end of the war until about 1960'After 1960,Germany
apPears
;npearsio hut grown at the samerate as it did prior to the war. In fact, Germanv
japan
War
II'
World
on
before
u'as
it
that
1960
since
path
:.-,iar,* been on th. ru*. growth
mida similar experience.ih. .ountry grew rapidly from the end o{thewar until the
the
to
compared
path
growth
balanced
a
higher
to
-d
moved
- i-Us when it appearsto have
rflr"t4ntv"-stgauf'*ert'ea4nital-lahn'^atin-anrl
illeru&r..,
Warrme:i rcasOn 6ei6re ille
ornlGDP per hour worked must haveincreased'
the Solorvgrowth
Why do countries return to the balancedgrowth path?We :*::t
5.15 shows for
-nrlel and the experiencesof Germany and Japantoi*pl"in rvhy.Figure

r ''=

Production,y

* =/1g3g

r ir-V

=ettHa o
=>:
-it

./l-

it rvason beforethe wirr.

lbtal FrotroinvDatirbase,
Sourcc':
Board:httP://
The Confercnce
ard.orgldatal
wryw.conference-bo
s
econo;nrdatabase/.

ffi

aL \

= at a*t
t
!t- -= :6

movedto a higherbalanced
growth path comParedto the one

Break-even irwestment
line, (d + nrk

L-

l-

-=O

3
L

sy

hwS

(d+ n)kre4s
l.'-

krgas
1. The,capitalllaboiratio
decreases af the end

k. = ktsgs
Capital-labor ratio, k

TheSolowGrowth
ModelandPost-World
in
War ll Convergence
Gerrnany
of Germant/s
Thedestruction
capitalstockat theendof lYorld
thecaPital-labor
WarII caused
frotn[* to
ratioto decrease
krgn: andrealGDPPerhour
'
frornt' trt
wprkedto decrease
GermanY
point,
that
At
/tg+s.
grorvth
rvasbelorvitsbalanced
exPgliGermanY
Postrtar
patir.
encedvervfastSrowthratesof
realGDPasthecountryraPidlY
goodswhile
caPital
accumrilated
growth
its balanced
aPProadring
path.s

5 r Long-RunEconomicCrowth
17$ cHAPTER

Germany the effect of the destruction of tlre capital on real GDP per hour rvorked-German'i
started off in the steady state prior to world war II, with a capital labor ratio, ft* : ft rs:e,
and real GDP per hour worked, f = ygts. Becausethe country was in the steadystate,it
was also on the balanced growth path, so according to Table 5.3 on page 163, the
capital-labor ratio and real GDP per hour worked both grew at a rareof I.5ga. By the end
of the war, Iarge portions of Germanyl capital stock had been destoyed.As a result, the
capital-labor ratio decreasedfrom ts to ft1e45,and real GDP per hour rvorked decreased
kam f to "/rg+s.The decreasein labor productivity causedthe decreasein real GDP per
capita at the end of \&brld War iI that we seein Figure 5.14.After the war had ended,total
factor productivity continued to grow, which causedreal GDP per hour worked and real
GDP per capita to grow. Horvever,becausethe capital-labor ratio had fallen to k1ea5,the
German economygrew for an additional reason:It accumulatedcapital more quidily thai
it had along the balancedgrorvth path.
At &19a5,
the level of investment, slrgqs,was greater than the break-evenlevel oi
investment, (d * n)k19a5,so the capital-labor ratio increasedtoward the steady-state
value of ,tl. From 1945to 1960,the capital-labor ratio in Germany increasedfor tr+'oreasons. First, total factor productivity growth was positive, so the growth rate of th:
capital-labor ratio along the balancedgrowth path was positive. Second,Germany u..a-,
convergingfrom the capital-labor ratio of ft1ea5
toward the steady-statecapital-labor raria
of F. Becausethe gron'th rate of the capital-labor ratio deterrninesthe growth rate of reai
GDP per hour worked, the growth rate of real GDP per hour worked rvasalso the resul:
of balancedgrowth due to total factor productivity growth and growth due to the convergenceof /D+s to y'. In general,I\re can think of the growth rate of real GDP per hou:
worked as:
gy = (Balancedgronth rate) + (Growthfrom convergence).
As long asthe capital-labor ratio is lessthan ts, growth from convergenceis positive.
so the German economywas growing more rapidly than it did along the balancedgrowth
path- Therefore,real GDP per hour worked convergedtoward y*, so real GDP per capita
convergedtoward the balancedgrowth path. In the very different situation rvherean economy starts off with a capital-labor ratio that is greaterthan ts, the capital-labor ratio will
decreaseover time, so grorvth from convergencewill be negative.As a result,the econom:;
will grow more slowlv than along the balancedgrowth path, so real GDp per worker \riii
conyergeto the balancedgrowth path.
Figure 5. t4 showsthat |apan experienceda similar decreasein real GDp per
a:
yp
the end of the War and then rapid growth after the War.

f,hina's5t*ru#ar{$
#{,L$rr$rs#'
#v*r ilw****$
tt"x-*-t
*r"ftl-c*
"#ilf
ii*iie* Siates?
In 2010,GDP per capita in the United Stateswasmore than six times higher than GDP pe:
capita in China. However,the growth rate of real GDP per capita in the United Stateshas
averagedonJy i.9oloper year since 1980comparedto Chinat averagerate of 8.9%oper year
over the sametime period. BecauseChina'sstandardof living is growing more rapidly than
in the United States,we could predict that China's standardof living will exceedthe U.S,
standardof living in the 1'ear2038.However,for China to maintain ix high ratesof grOwth
in real GDP per capita,it lvould harc to maintain high ratesof growth for total factor productiviry which is unlikely for severalreasons.First, the United Statesinvestsmore in activitieg suchas researchand developnrent,that resultin new technologiesand increasesin total
factor productivity. Second,much of Chinat growth is likeh due to the transition fron a

Equilibrium171
andLong-Run
crowth path,Convergence,
TheBalanced
* China'sgowth rateis-likelyto decrease
centrallyplannedeconomyto 1 mlka e31:T,u'
the transition 1o a market
;;;b"bly U.tt to thinliof
asthe transitioo i. **piriliil
tllt: of growth in real
htgl
The
higher.
gt"t-tli p"th
economyasmovingCd;'t t"l;."i
the
tT.trigt'er g"'o$th.lath'e'l Chinaapproaches
GDPper capitaared".;;;;;;;;;;
to
growth rate to decrease a
newhigherbalancedgro;; p"fi, we would eipeciCttinut
rnoresustainablerate.
Anotherloomingproblemisdemographic.BecauseofChina!lowbirthrate,itwill
the populationof
the next two decades'
,oon experiencea declinain its labor force.ouer
by about100milhon,or about30olo'
nrenandlyomenu"*".nJi "ia ir y*tr will-fall
ln oltler workers,a grouPthlt will likely beless
Chinawill alsoexperien;;;i"A;.r!are
*orkers.Givencurrenttrends,the U.s. census
and lesst
e,lucated
"urtny;h;y";;g.r
i, china in 2030thantoday,with ferverin their
Bureauprojectsf.*., ;;pi;;"iffiso
older'Moreominousis that Chinahas
lOsandearly30sand manymoreintheir 69.:.*d
producfor enhancing
haspotentialsources
:o nationalpubti. peorii-n'rffi. dti"a still
jobs
and
ro *or. productiveurban
'iider
;viqv,includingthe rnigi;;;_;f ,yil rvorkers
'k"o'-how'
canfuelfuturegrowth'but at somepoint'
factors
These
ar'licationof t".hoi.uf
growth'
Jttir"t i""tographic problemscouldslow
offersa soberinglesson:Throughout
two"decades
rll
,rrg
Theexperienr",f i;;;;;;
about
states,andtherervasmuchdiscussion
:--re1g70s,
Iapangrewf;;; th"" the united
1990s'
the
in
But
U"i1ta Statesin real GDP per capita'
n'henfapan*oota ,,,,f-*-'
wellbelorvthe rateof
'tt"
;iler capitaGDprvasonly0.5016,
annual;r;;il;";.
irpans average
of growthof total
rate
the
in
a decrease
:m*rrh of theunitedd;;,;J;rytit"ntiit*ted
the coun2000s,
early
the
during
:rctor productirity.Alth;;;n grr"li, i" Iapan"increased
will
china
\4rtrether
1990.
the growth ratesof *. 1o1rtbeforJ
:-r hasneverapproached
remainsto be seen'
,f i" t"ff.t ,"pii a"cnt't in grorvthrates
"
8?:lo 5' November/
Aflairs,Vg!
Foreign
"TheDemographic.Future,"
Eberstadt,
Nicholas
A Lost
inJapan:
1990s
---o*rrces:
"The
Prescott,
cl
and.E-dward
2010,pp.s+-+q;i[{u^,o ilayashi
le:ember
/ wp/wp617'pdf
1...0.; " t*rrl.rninnuupolisfed'org/research
:'.:viltiir"rnii*lsta**lirtgbyd*i*gr*latedp;'chi'll;d'ic'i:*:gelSSalth*e*dafthis
:i. --]if i'.
::r:tr*stsr##@'/"'2i*Xa!!)&!t*:A{t$H-t!tl.$ryLit*-'svjPl4y?*:$81+Ko'$itd'F!9q

for an
ofreal GDP per capitawould look like
Figure 5.16 showswhat the time paths
S" bd-T:t1

p"th' an econ'omyinitiAty Ptt:l

ionomyinitially on tf'e ialanctJ g&lh
growthpath.If an economyrs
uu*. the balanced
srowrhpath,and .ron-o*y iniriiny
off
"n
thepathuntil arieventmovestheeconom
,-n thebalancedgrowthprifr,'irr"*oins on
growthpath'thegrou4hrateof realGDP
*e path.Whentfr. ..o"J"f it "" *f* f'"f*ced
PotentialTimePathsfor
RealCDPPerCapita

6E
E'a
ri G

Oo
2l-

EO
E o.
ioEO

TimePathfor a countryinitiallY
abovethe balancd growthPath

Balanced growth Path

economyoff the Path-If an econstartsoii belorvthe balanced

om,,v
grorvthPath,theeconomySrolvs
iasterthan it would alongthe bal-

8s
6
L.
_ __ :-

6
z

li an econotnyis on thebalanced
growth path,it rentainson the
pathuntil an eventm(|Yesthe

i_:r:::i::ii_

:s:J'::i*i:':''

TirnePathfor a countryinitiatlY
belowthe balancedgroMhPath

Time

ancedgon'th Path.lf an econony

startsotf abovettre balanced
growth Path,the economYgro\rs
more slowlYthan invould along
the balancedgrorvthP6[' s

172 CHAPTER
5 r Long-RunEconomicGrowth

#ffiffi

Summary
of Adjustunents
to theSteady
State
m growth frarn
csnvergence
is ...

lf ...

th* capitalfa.bsF
ratio .,.

k:k*

equalsthe steady-state
value

zero

equalsthe balancedgrowth rate,and the econorny

remainson the balancedgrowth path.

k>k"

is greaterthan the
steady-state
value

negative

is lessthan the balancedgrowth:rate,so the economy

convergesto the balancedgrowth path,

k<k*

is fessthan the
steady-state
value

positive

is greaterthan the balancedgrowth rate,so the

economyconvergesto the balancedgrowth path.

and the grcwth rale *f the e{onorfif,...

per capita is determined by the growth rate of total fastor productivity. If an econo=-,
starts off below the balancedgrowth path, growth from convergenceis positive, so ;l*
economygrorvsfasterthan it rvould along the balancedgrowth path, and it eventuallycr':trges to the balancedgrowth path. If an economy starts off abovethe balancedgror'=
path, growth from convergenceis negative,so the economy grows more slowly thaa ::
would along the balancedgrorvth path, and it eventuallyconyergesto the balancedgror.-:
path. Table 5.4 providesa summary of adjustmentsto the steadystate.
#* -&tr$
{t"ll**!e:
i*n':*ry*
t* th* gssyts Sa}en*e*d 6rc}st$.! Sixt*'r?
Our discussionso far suggeststhat countriesel'entuallyconyergeto their balancedgror,.-:
paths.But doesthis mean that all countriesconvergeto the samcbalancedgrowlh path ar,:
the samelevelof realGDP per capita'?That seemsunlikely becausereal GDP per capitavariei
dramaticallvamong countries.In 2010,real GDP per capita for the alragecountry in rh.:
rvorld was 59,+00.RealGDP per capita in the United Stateswas $47,400.The country rvi::
the lo*'est real GDP per capitawas the DernocraticRepublicof tlre Congo,at g300,so ti::
a!'erasepersonin the United Stateshad an income 158times that of the averagepersonin ri::
Congo.Economistshavespent a greatdeal of tirne and effort studving whether poor cou::tries suchasthe Congoeventuallyconvergeto the samereal GDP per capitaascountriestha:
areaLrea,{'rich suchasthe United States.Economistsusethe tem convergenceto
describeth.:
--rorssoi poor countriescatchingup to the real GDP per capitaof rich countries.
Figure 5.1 on page 145makesit clear that convergencedoesnot seemto be occurring.
lapan caught up to the rich Westerncountries during the twentieth centuy, and there are
signs '.hat China is catching up to rich countries now. However, many countries in subSaharanAfrica suchasthe DemocraticRepublicof the Congo seemto havepersistentlylon
real GDP per capita over long periods of time. Theseregions and countries are not conlereing to the rich nations.\44ry?
The prediction of convergencecomesfrom the Sololv growth model, when all counlries hare the same balancedgrowth path. Horvever,if the balancedgrowth path differs
arnong coultries due to dift'erentsavingrates,labor force growth rates,or growth ratesof
total l'actorproductivitl', countrieswill not havethe samebalancedgrowth path. Insteadoi
convergence,countries exhibit conditionslconvergencea
whereeachcountry convergesto its
own balancedgronth path. Researchby N. Gregory Mankiw of Harvard Universitv,David
Romer of the University of California at BerkeleSand David Weil of Brown Universitv
showsthat once you accountfor differencesin the balancedgrorvth path due to differences
in saving rates,human capital,social institutions, and so on, countries convergeat a rate of
about 2o/oper ,vear.16
This rate of convergenceis so slow that it will take about 35 yearsfor
a poor country to close half the gap betweenits current real GDP per capita and the real
GDP per capita on the balancedgrowth path. Moreover, if low-income countries do not

t6N.GregoryMankiq David Romer,and l)avid lVeil,'A Contribution to the Empirics Lconomic

of
Growth," QuarterlyI ournal of Ecouomics,Vol.I 07, No. 2, May | 992,pp. 407437 .

TheBalanced
crowth path,convergence,
andLong-Run
Equiribrium1r3
foseasetheir savingrategincreasehumancapital,gr takeother
mcasures
to increasetotal
fuctorproductivity'tl-r9gapin realGDp per capitabetneenhigh-incorne
and low-income
'rauntriesrvill neverdisappear.

Answeringthe Key euestion

Ai the beginningof this chapter,we askedthe question:

Continuedfram page i 43

'',Vhyisn'tthe wholeworld rich?"

cur discussion
hasshownthat the growth
is the keydetermipant
of the
1at9oj laborproductivity
g'owthrateof the standardof livint. 8ut what
determines
*relrowtn rateoi raooifroauctivity;
to.the solow.growth.model,
'{ccording
the growthrateof total"faaorproductivityis the determinant
of the growthrateof.laborproductivity.
AsI resuh,,totar
fagtorproau.tioitygrowthcauses
improveri''enEin the standardof living-andeconomic
growthoverthe dn! ,un. we alsosawthat thereis no
*ngfe{actorthat causes
total}actorproductivily.to
grow.TheleveT
of t"cr'notCihe qJdity of the
f
hq
force,
thequality
government
of
andsociafinitituuons,-geolr"pt'y,
I
anatriJ'qrJiiT-Lrtinanciat
msiitutions
alfpfayan,important
role.in explaining
differencesTn
t6tuiruao,.t;jr;ti;;il across
countries.
if a countryfailsto achieve
sustained
economic
g-rowth
then,it isdueto itsfailurein oneor moreof
lheseareas'Therefore,
whifesomecountries rirprv unluckybecause
of theirgeography,
otf,er
3t-"
countries
arepoorbecause
of institutions
thattheirgo*rn*.ntt areunable,o. ,i*iirini to reform.

Befbremoving on to chapter 6, read An InsideLookon the nex.tpagefor

a comparison
_
m':rojected econorhicgrowth ratesin India and China.

AN INSIDELOOK

Will lndiaCatchUpWithChina?

Lap:
TheFastest
Is
IndidsEconomy
Racingwith
Ctrina's
No other pair of countries invites
strch frequent comparison yet share
so little in common. China is bigger, stronger, richer and better
organised than India, the onlY
other country with over a billion
people. And yet Indians, it is fair to
saf, et loy the comParisons with
their northern neighbour more
than the Chinese do. It was an
lndian rvho coined the word
Chindia- lndia relishes being in the
salne leagueas China, eYenif it
losesmost of the games.
In 201I, howel'er,India ma)'
win a round- According to some
projections, its econorn)' rna)' gro\tas fast as China's. [t mq'eYen grow
a little faster.
g
By the conYentionsoi Indian
national accountitg, nst )'ear
begins on April tst and ends on
March 3lst }al[' over that P'eriod'
the World Bank exPectslndia's
econom,vto grow by 8.790'slightl)'
faster than the 8.506growth it has
forecast for China oYer the calendar

be a rare
year.That is hardlythe consensus O It would, nonetheless,
grown
not
has
India
achievement.
view.But it is not an isolatedone
1990.
since
China
than
faster
' . ' If
either.. . .
India is to pip Chinaagainin 2011'
Although only a handfulof
severalstarswill alsohaveto fall
economiststhink India'sgrowth
i ntoal i gnrne,nt....
will outpaceChina'snext Yeer,a
India s economYmust maintain
largernumberbelieveit will do so
despiteits central
momentum,
its
this decade.The reasonsarelargely
againststubbornly
campaign
bank's
econonrY
China's
demographic.
high intlation.And China'smust
cannotgo on rapidlyexpanding
CLSAforecasts
slow appreciaL,ly.
onceits labourforcestartsshrinkwill
that the Chineseeconom,Y
ing. Thanksto its one-childPoliry,
in 2011,down frorn
grolvby 8016
introducedin L979,thenumberof
in 2010.
10Vo
youngChinese( I 5-29-year-olds)
a (relatively)lorv exPectaSuch
l,
201
after
rvill fall quite sharply
tion for growth reflectsa high
deprivingthe countrl"sfactoriesof
nomadic,nimble-fingeredr+'orkers. opinion of China'sleaders.That
soundsparadoxical-surelvslolver
Within a coupleof )ars,Chinese
growth is a sign of Poliry failure,
)'oungstersrr"illbe outnumberedby
But China'sleadersno
success?
not
their tndianpeers,eventhough
at anYcost.[f
growth
seek
Ionger
rvill
match
not
population
India's
thq, believervhatthey saY;theY
China'suntil about2025.
would rvelcomea lessbreakneck
O India rnayalsooutpaceChina
paceof economicexpansiofi.. - .
for the simplereason
rhis decad,e
India still hasmassivecatching
that it is poorer'givingit more
to do in infrastructure.It is not
up
income
scopeto catchup. India's
yet clear,with due respectto Indian
per headrvouldhaveto grow at \a/o
nationalists,whetherIndia will
a yearfor I 7 yearsto matchthe
becomethe rvorld'sfastest-growing
ler"elChina enjol'stoday.One year
big economyin 2011'. . .
of fastergrowthdoesnot, then,
overmeanthat India is somehor,v
laP:India's
"Thefastest
Source;
taking China.Rather,it is like a
economy is racing with China's," The
a
faster
doing
runner
5,000-metre
Economist;November 22,2010' @ The
EconomistNewspaperLimited,London
lap than the frontrunner,who is
(Novernber22, 2010).
five lapsahead.

Key Points in the Article

*s a,tide discussesprojectedeconomic
plrr*rth in lndia and China. After rnore
t".ar 20 yean of traillng China in annual
gqr*'ffi, some economicprojectionsshow
mfi,e'sgrowth rate rnay actually equaf or
rr-r=ss Srat of Chinaduring this decade,
Ie*eral factors have led economiststo
f'rs :cndusion,including(1) the growing
;;;:: it India'slabor force and (2) the fact
f.:: per capitaincorneis lessin India than
,lnn.na,
leadingto a more rapid rate of
'rrr-'r 3;gencebetweenthe two nations.
i"maiyri*g the f.les$s
population
61 Aiihough China'soverafl
f| q expectedto outnurnberlndia'sfor
1*r --ext15 years,the sizeof the
I*rri.eslaborforcewill soon declinedue
r :re country'sone-childpolicy,a popu,,rtr'ir-controlmeasureinstituted in 1978
most Chinesefamiliesto only
t-c ,,innib
:r-e :hild per household.Wthin the next
r*$q'/ears,lndia'spopulationof
" 5-:,r29-year-oldsis projectedto
;rn,assthat of China,giving India a
ir;6rgr',larger,healthier,and possibly
r{:re educatedworkforce.Thesederno{,fas'xicchangeswill give India a better
trirr,ltrrni$ to experiencefaster eco'r'pl*',growth in the coming decades.
1q {ccording to the ClAs World
El ;actboak,lndia'srealCDP per capita
lr,,n,,as
53,400in 2010, lessthan one-half of
;:i'ficandy lower Wr capitaincome,less
mfr*ieconomicgrowth is neededin lndia
',ira: in Chinafor the annualpercentage
rT?ass in grow$r in thesetwo nations
tr :p{,tverge.Evenif lndia does surpass
l-rma in annualeconomicgrowth, India
tffi a long way to go to overtakeChina in
ur :apta income.At an annualgrowth
;rr: cf 8"/o,lndiawould stillneedjust
10 yearsto equalthe per capita
r**,s'in Chinain 2010.
r-Lrl{:qe
with a considerablylower per
iven
"q
$t :"pita incorne,surpassingChina's
nr,r;al gowth rate would be a significant
ei:,:cmic rnilestonefor India,as this feat
-;s rct beenachievedin more than 20
,';-5 The figure showsactual and prory::C gowth in CDP for lndia and China
rrr* 2CO6through 2015. The actual
:rs--s through 2W9 show a consistently

higherCDP growth rate in Chinathan in

India-with projectionsthat the gap will
narow considerablyin 2An; the gap will
disappearin 2A$; and lndia will overtake
Chinain 2A16. Afew econornisbpredict
that this gap will closeeven faster,perhapsas soonas 2011, but for this outcometo occurtndiamust maintainits
growth momenturnwhile growth in
subside.
Chinawill needto substantially
T}iIilIKINfi CRffiCALLY
1. Laborproductivityin emergingnations
suchas lndiaand Chinahasgrown
significantlyin recentyear. The
growth rate of tolal factor proCuctivity
is the key determinantfor labor productivity grawth and the growth rate
of the standardof livingwhen labor
inputsper personare constant.Using
the formulasfor steady-stategrowth
ratesand the data in the table for
2008, calcufatethe annualincreasesin
laborproductivi$and realCDP for
both Indiaand China.Basedon Your

explainwhichof thesecounanswers,
trieshasa higherrateof growthin ib
of living.
standard
lndia

t?air'a

A37 0.58
shareof
Capital's
income
Totalfactorproduc-0,010 0.013
tivity growth rate
labor
Potential
0.058 0.065
hoursgrowthrate
2. Total factor productivityin emerging
economieslike thoseof lndia and
leadChinais growingsignificantly,
ing to increasedefficiencyfor both
workei'sand firrns.What effectdoes
an increasein ioLalfactor productivity
valuesof
have on the sieady-state
the capital-labori'atioand real CDP
per hour vrorked?Wlty? Usea
graph showinga one-timeincrease
in total factor producivily to illustrate your answei-.

Stowing dragon,
crouchlng tlger
GDP grorth, %

2006 20a72008200920102011 2012z}fi 2A1420152016

Forecast

growthin CDR2AA5-2015
Actualandproiected
l.irnited,l,ondon(Novernber22,2Ai0).s
Nervspraper
Source:O lhe Econonrist

An lnsideLook 175