CHAPTER 24 PRODUCTION AND GROWTH 549
especially important for technological progress. There is no doubt that these issues
are among the most important in economics. The success of one generation’s poli-
cymakers in learning and heeding the fundamental lessons about economic
growth determines what kind of world the next generation will inherit.
higher trade barriers; excessive tax
rates; lower saving rates; and adverse
structural conditions, including an unusu-
ally high incidence of inaccessibility to
the sea (15 of 53 countries are land-
locked). . . .
If the policies are largely to blame,
why, then, were they adopted? The his-
torical origins of Africa’s antimarket ori-
entation are not hard to discern. After
almost a century of colonial depreda-
tions, African nations understandably if
erroneously viewed open trade and for-
eign capital as a threat to national sover-
eignty. As in Sukarno’s Indonesia,
Nehru’s India, and Peron’s Argentina,
“self sufficiency” and “state leader-
ship,” including state ownership of much
of industry, became the guideposts of
the economy. As a result, most of Africa
went into a largely self-imposed eco-
nomic exile. . . .
Adam Smith in 1755 famously
remarked that “little else is requisite to
carry a state to the highest degrees of
opulence from the lowest barbarism, but

and higher now prevalent in Africa, to
rates between 20 percent and 30 per-
cent, as in the outward-oriented East
Asian economies. . . .
Adam Smith spoke of a “tolerable”
administration of justice, not perfect jus-
tice. Market liberalization is the primary
key to strengthening the rule of law. Free
trade, currency convertibility and auto-
matic incorporation of business vastly
reduce the scope for official corruption
and allow the government to focus on
the real public goods—internal public
order, the judicial system, basic pub-
lic health and education, and monetary
stability. . . .
All of this is possible only if the gov-
ernment itself has held its own spending
to the necessary minimum. The Asian
economies show how to function with
government spending of 20 percent of
GDP or less (China gets by with just 13
percent). Education can usefully absorb
around 5 percent of GDP; health, an-
other 3 percent; public administration,
2 percent; the army and police, 3 per-
cent. Government investment spending
can be held to 5 percent of GDP but only
if the private sector is invited to pro-
vide infrastructure in telecommunica-

physical capital, human capital, natural resources, and
technological knowledge available to workers.
◆ Government policies can influence the economy’s
growth rate in many ways: encouraging saving and
investment, encouraging investment from abroad,
fostering education, maintaining property rights and
political stability, allowing free trade, controlling
population growth, and promoting the research and
development of new technologies.
◆ The accumulation of capital is subject to diminishing
returns: The more capital an economy has, the less
additional output the economy gets from an extra unit
of capital. Because of diminishing returns, higher saving
leads to higher growth for a period of time, but growth
eventually slows down as the economy approaches a
higher level of capital, productivity, and income. Also
because of diminishing returns, the return to capital is
especially high in poor countries. Other things equal,
these countries can grow faster because of the catch-up
effect.
Summary
productivity, p. 533
physical capital, p. 534
human capital, p. 534
natural resources, p. 534
technological knowledge, p. 535
diminishing returns, p. 539
catch-up effect, p. 539
Key Concepts
1. What does the level of a nation’s GDP measure? What

Problems and Applications
CHAPTER 24 PRODUCTION AND GROWTH 551
3. U.S. income per person today is roughly eight times
what it was a century ago. Many other countries have
also experienced significant growth over that period.
What are some specific ways in which your standard of
living differs from that of your great-grandparents?
4. The chapter discusses how employment has declined
relative to output in the farm sector. Can you think of
another sector of the economy where the same
phenomenon has occurred more recently? Would you
consider the change in employment in this sector to
represent a success or a failure from the standpoint of
society as a whole?
5. Suppose that society decided to reduce consumption
and increase investment.
a. How would this change affect economic growth?
b. What groups in society would benefit from this
change? What groups might be hurt?
6. Societies choose what share of their resources to devote
to consumption and what share to devote to investment.
Some of these decisions involve private spending;
others involve government spending.
a. Describe some forms of private spending that
represent consumption, and some forms that
represent investment.
b. Describe some forms of government spending that
represent consumption, and some forms that
represent investment.
7. What is the opportunity cost of investing in capital? Do

growth lead to political stability?

IN THIS CHAPTER
YOU WILL . . .
Consider how
government budget
deficits affect the
U.S. economy
Develop a model of
the supply and
demand for loanable
funds in financial
markets
Learn about some of
the important
financial
institutions in the
U.S. economy
Consider how the
financial system is
related to key
macroeconomic
variables
Use the loanable-
funds model to
analyze various
government policies
Imagine that you have just graduated from college (with a degree in economics, of
course) and you decide to start your own business—an economic forecasting firm.
Before you make any money selling your forecasts, you have to incur substantial