[MUSIC] Now that we have identified the various factors that determine economic growth, let's to turn to a discussion of their relative importance. And here there is much controversy. While some economists and policy makers stress the need to increase capital investment, others advocate measures to stimulate research and development and technological change. Still a third group emphasizes the role of a better educated work force. To better understand this controversy, it is useful to trace the history of growth theory. Early economists like Adam Smith and Thomas Malthus stressed the critical role of land in economic growth. The Wealth of Nations, published in 1776, Adam Smith provided a handbook of economic development. He began with a hypothetical, idyllic age. That original state of things, which precedes both the appropriation of land and the accumulation of capital stock. This was a time when land was freely available to all and before capital accumulation had begun to matter. What would be the dynamics of economic growth in such a golden age? Because land is freely available, people simply spread out onto more acres as the population increases, just as the settlers did in the American west. because there is no capital, national output exactly doubles as population doubles. What about real wages? Wages earn the entire national income, because there is no subtraction for land rent or interest on capital. Output expands in step with population, so the real wage per worker is constant over time. But this golden age cannot continue forever. Eventually, as population growth continues, all the land will be occupied. Once the frontier disappears, balanced growth of land, labor and output is no longer possible. New laborers begin to crowd onto already worked soils. Land becomes scarce and rents rise to ration it among different uses. Population still grows and so does the national product. But output must grow more slowly than does population. Why? Because of an immutable law known in economics as the law of diminishing returns. It's a law discussed much more fully in microeconomics, however in this context it is an easy law to explain. Specifically, with new laborers added to a fixed supply of land each worker now has less land to work with. This increasing labor to land ratio means that, at some point, the extra or marginal product of each additional worker must begin to decrease. And so, too, must the workers real wages because of this decline in productivity. How bad could get things get? The Dower Reverend Thomas Malthus thought that population pressures would drive the economy to a point where workers were at a minimum level of subsistence. In particular, Malthus reasoned that whenever wages were above the subsistence level, population would expand. While below subsistence wages would lead to high mortality and population decline. Therefore, Malthus reasoned, only at the level of subsistence wages could there be a stable equilibrium of population. And in this world, Malthus believed that the working classes would be destined to a life that, in the words of the philosopher Thomas Hobbes, would be nasty, brutish, and short. In fact it was this gloomy Malthusian picture that lead to the critical depiction of economics as the dismal science. These figures contrast the process of economic growth in Adams Smith's golden age, versus the Malthusian gloom. In the left hand figure as population doubles the production possibility frontier or PPF shifts out by a factor of two in each direction. Showing that 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. Lowering per capita output as more people crowd on a limited land and diminishing returns drive down output per person. The ultimate result can be seen in these figures. In the left-hand figure we see the red line rising exponentially past both straight line projections for wheat and barley and oat production into a Malthusian doomsday. The right-hand figure shows how bushels per capita decline over time due to diminishing returns. Fortunately, Malthus' dismal forecast was dramatically wide of the mark because Malthus did not recognize that technological innovation and capital investment could overcome the law of diminishing returns. As a result, land did not become the limiting factor in production. Instead the industrial revolution brought forth power driven machinery that increased production. Factories that gathered teams of workers into giant firms. Railroads and steamships that linked together the far points of the world. And iron and steel that made possible stronger machines and faster locomotives. Moreover, as 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 effecting economic development.
