[MUSIC] In our last module we looked at the four wheels of growth upon which a nation's engine of economic growth rides. Human resources, natural resources, rate of capital formation, and its technological advancement. Let's turn now to a discussion of the relative importance of each of these wheels, and here there is much controversy. For example, some economists and policymakers insist that the growth process is all about increasing capital investment while others advocate measures to stimulate research and development, and thereby spur technological change. Still a third group emphasis the role of a better educated workforce as a solution to any nation's growth roles. Better understand this controversy, it is useful to trace the history of growth theory. Early classical economist, like Adam Smith and Thomas Malthus, stressed a critical role of land in economic growth during the 18th century and early 19th century. For example, in his path breaking book The Wealth of Nations, published in 1776, Adam Smith provided the first handbook of economic development. Smith's treatise began with a hypothetical idyllic age in which land was freely available to all, and there was not as yet any capital accumulation. With land freely available, people simply spread out onto more acres as the population increased, just as the settlers did in the early American west. Because there was no capital accumulation, national output exactly doubled as population doubled. Now, what about the level of real wages? Well, because there is neither any rent to pay on land, nor interest to pay on capital, wages in Adam Smith's idyllic land simply equaled the national income. Moreover, because output expands in step with population, the real wage per worker is constant over time. [MUSIC] Of course, this golden age of freely available land cannot last forever. So in the next stage of the Adam Smith growth model, the frontier disappears, and new laborers begin to crowd onto already worked soil. At this point, land becomes scarce, and land rents rise to ration the land, among its many different uses, of course the population still grows along with the gross domestic output. However, output and GDP must grow more slowly than does the population, just why do you think this is so? Please jot down a few ideas before moving on, and here's a hint, the reason may be traced to an immutable law that you may have learned about in microeconomics. [MUSIC] So why does growth begin to slow down in Adam Smith's model as soon as land becomes scarce? It's because of an immutable law known as the Law of Diminishing Returns. While the Law of Diminishing Returns is discussed much more fully in microeconomics, in this context it is an easy law to explain. Specifically, when you add additional laborers to a fixed supply of land, each worker has less land to work with. This increasing labor-land ratio means that, at some point, the extra or marginal product of each additional worker must begin to decrease. So what do you think happens to real wages in this case and why? Please jot down your answer before moving on. [MUSIC] So what happens to real wages is, the land gets more crowed. Real wages of course decline because of falling worker productivity. But just how bad can things get in any given nation as the land becomes more and more crowded? According to Thomas Malthus, things can get very bad in deed. In fact, Malthus argued that population pressures would inevitably drive the economy to a point where workers wages would be set at a minimum level of subsistence. He reasoned that if wages were above the subsistence level, the population will expand and drive ways drive back to subsistence levels. In contrast, if wages fell below subsistence wages, people would die of starvation and as the population fell wages would rise back up to subsistence levels. So what is the stable equilibrium in Thomas Malthus' world? He reasoned that only at a level of subsistence wages would the population be at a stable level, and in this world of subsistence living, Malthus believed that the working classes would be destined to a life that, in the words of philosopher Thomas Hobbes, would be nasty, brutish, and short. In fact, it was this gloomy Malthusian picture that led to the critical depiction of economics as, The Dismal Science. [MUSIC] These figures contrast the process of economic growth in Adam Smith's Golden Age, versus that of Malthusian Gloom. On the left-hand figure, as population doubles, the production possibilities frontier, or PPF, shifts out by a factor of two in each direction, thus showing there are no constraints on growth from land or resources. In contrast, the right-hand figure shows the pessimistic Malthusian case, where a doubling of population leads to a less than doubling of food and clothing. This implies a lower per capita output as more people crowd onto the land and diminishing returns do indeed drive down output per person. [MUSIC] So things did indeed look pretty bleak to the likes of Thomas Malthus in the early 1800s, and he surely must have been not a lot of fun to be around at any dinner gathering or party. The question of course is, why was Malthus so wrong about his doomsday predictions? To put this another way, what was the biggest thing that was missing from Malthus' theory? Take a few minutes now to jot down some ideas before moving on. [MUSIC] Of course what Thomas Malthus didn't see coming in the early 1800s was the importance of technology, and an industrial revolution that would greatly reduce the importance of land, per say, in the growth process. During that industrial revolution, power driven machinery emerged to increase production. Factories gathered teams of managers and workers into giant firms. Railroads and steam ships linked together the far points of the world into a global trading matrix, and Iron and steel made possible stronger machines and faster locomotives. Moreover, as the world's market economies entered the 20th century, important new industries grew up around the telephone, the automobile, and electric power while capital accumulation and new technologies became the dominant force affecting economic development. In short, with the arrival of the 20th century, it was time for a new model of growth that captured a very new reality, enter stage right, the neoclassical growth model, developed by Nobel laureate and MIT professor, Robert Solow. It is to the explication of that model we will turn to in the next module, and it really provides a startling set of insights into the process of growth and productivity. When you're ready, let's move right on. [MUSIC]
