THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS
1. Link between growth/development and the various factors of production of the commodities:
Before we move ahead to the neo-classical and endogenous growth theories, let us expand a better understanding of the link between growth/development and the various factors of production of the commodity. We start by recalling familiar Cobb-Douglas constant returns to the scale production function: Y = KαL1-α for the hypothetical economy. At this time Y denotes output, K denotes capital such as machines, buildings etc., L denotes labour, and α is a parameter which lies between 0 and 1. Dividing both sides by L and substituting Y/L = y (per capita output), and the K/L = k (per capita capital), we have per capita production function y = kα.
2. Labour and Capital:
Now for the given L and no depreciation, the increase in K should translate into the rise in k and through it the increase in y. This is an instance of capital deepening induced growth. Though, when there is depreciation (say at the rate d% p.a.) of the capital stock and of the labour supply is growing/developing at n% p.a., capital should grow at least by (d+n)% p.a. in order to keep the K/L, or k, constant. This is known as capital widening, i.e. more capital being created but spread over the larger population so to deliver the same K/L. The per capita output impact of capital widening is zero, because k relics the same.
At present taking capital as predetermined, let's analyze the ways in which the labour can serve as the engine of growth/development. It is obvious that rise in the no. of labour hours worked would enlarge output. Though, historically, the working week has been short from 6 to 5 days so it would be mistaken to cite this as the main source of world economic growth over the last period of century. What else could then have driven the rapid growth of production in the 20th century? It may be the case that there are now extra people on the labour force, due to the perhaps a larger proportion of women performing marketable jobs which is accurate historically Then it may be that the quality of the human capital has gone up. The same workers, because they are improved, educated and have better skills, can produce more output using same quantity of capital. Japan and Germany are the chief examples of this - i.e. of countries which achieved extremely high growth rates despite having very low levels of physical capital left after the World War II. It was the worth of these countries' human capital which created the difference.
Let's now concentrate on the land or property. The initial thinking on this was all the doom and gloom. Malthus (1798), for example, noted that the supply of land, especially agricultural land, was fixed, whereas world population was rising at very fast rate. Given diminishing returns (in the terms of marginal food product) to labour, the implication was so obvious: world hunger. While starvation hypothesis did come true for some of the countries, it did not happen to the whole world. Why? Predominantly because of the unanticipated productivity improvements in the agricultural production. Technological breakthroughs, such as tractors, fertilizers, etc. Increased yields per acre by many 100s of percents permitting a food output which far exceeded the world food needs even with a larger population. Today, land does not feature centrally in growth/development theory, as number of countries (such as European countries, Japan, Singapore, Hong Kong, etc. were seen to achieve very high growth/development rates while geographically much big South Asian, Latin American and African countries lagged behind.
Land is one type of natural resource which goes into production. The other type is raw materials such as mineral wealth or timber. The important summit about these resources is that some of them are not renewable (such as oil, coal, gas and the other minerals), while others are: fish, timer, etc. It is significant to take these concerns into the consideration when talking about the capability of a particular type of natural resource to act as the engine of growth.
The above stated is not true for the technical progress, however, which neither depletes nor needs renewing. An essential and significant ingredient in the production process, the technical knowledge/stock of the country is additive and cumulative and depends upon the pace of innovation invention, and learning by doing that is happening in an economy. In order to protect the incentive to invent and innovate, governments introduce patent and the copyright laws which grant the creator monopoly production rights for the certain period of time. Also governments directly or indirectly finance research and development activities which are the engine for invention and innovation.