Demystifying Economic Growth

The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 1971 was awarded to Simon Kuznets, for his empirically founded interpretation of economic growth which has led to new and deepened insight into the economic and social structure and process of development. 

I always used to wonder how can one determine the economic growth, I used to think how will government know how much I am earning, how much I am spending and how much I am saving. The thing which was even more perplexing for me was how would the statisticians or the government agencies would arrive at per capita income. There are just more than a billion individual living in India, and it is just impossible to ask each individual about their income. Well, actually we can, we can get a good approximation of total spending in an economy, total savings in an economy, and we can figure out how much an average citizen in an economy earns.

Like most of the economist Simon Kuznets loved data. He worked with lot of macroeconomic data and found out how to best use these data. His Nobel Prize was dedicated for establishing the means and the format for collecting the empirical data necessary to complete and make usable macroeconomic models.

Simon Kuznet was born to a Jewish family in Kharkov, the second largest city in Ukraine since the country’s independence from the Soviet Union in 1991.  Kuznets migrated to United States after the World War I, and resumed his studies at Columbia University. He was very influence by Joseph Schumpeter and his theory of innovation and business cycle. His doctoral thesis was published as book “Secular Movements in Production and Prices” in 1930. He joined National Bureau of Economic Research (NBER) in 1927, and then as apart-time professor at University of Pennsylvania. Kuznet joined Johns Hopkins University in 1954 as Professor of Political Economy and then from 1961 till his retirement he was a Professor at Harvard University.

I did got a chance to resolve my confusion and could learn how the economic growth and per capita is calculated. It is not very easy to calculate and work with data, but quite interesting to know how it is calculated.

Calculation of per capita income or disposable income

Simon Kuznet was one of the pioneer who contributed to the construction of national income accounts that represents the total economic data about a nation’s total production, consumption and about macroeconomic factors like interest rates, level of unemployment, inflation etc. The national income accounts have four components: investment, government spending, consumption, and net exports as defined in Keynesian theory. The total spending in all of these categories is called Gross Domestic Product (GDP). The GDP is the sum of  value of final goods and services produced in a country in a particular year. The GDP can be further divided or categorised into Nominal GDP and Real GDP. The Nominal GDP values from a time period to a different time period captures the differences or changes in the quantities produced, while Real GDP captures the changes in prices i.e. they are adjusted for inflation. In 2014, as per the data by World Bank, the GDP of United States was $17.4 trillion, GDP of India was $2 trillion, and lowest GDP is of Tuvalu $38 million.

Essentially, GDP is the production of new wealth in a country. But not every investment in an economy contributes towards generation of new wealth. For example if a manufacturer of goods replaces worn out machinery then it will not be generating more goods, such investments can be considered for depreciation and can be deducted form GDP to arrive at Net Domestic Product (NDP).

Whenever a consumer buys a good at its final value, not all the amount goes to the producer. The producer have to pay a certain percentage of money to local, state or central government in the form of taxes. These taxes are known as indirect taxes, which a consumer pay on buying goods and not on their incomes. The revenue which is left with businesses after paying tax is what we called National Income and it is the income earned by factors of production: land, labor, capital, and entrepreneurship.

Before the businesses distribute the revenue to the factors of production, there are some amounts to be deducted from the National Income for transfer payments such as Social Security Contribution, Corporate Income taxes. These payments differ from country to country. After making all these subtractions and addition from GDP, it would yield Personal Income.

We are almost there to calculate disposable income. The Personal Income which we calculated is not ready to be spend by the factors of production. The last step is to deduct personal income taxes or what we call as direct taxes from the personal income and what we will have is called Disposable Income. The Disposable Income divided by the total population of a country will yield Per Capita Income. It looks more simple when we work with actual data, and sometime numbers helps us to tell more than what we want to know or we want to learn.

References:

Kuznets S. (1959), Six Lectures on Economic Growth, The free press of glencoe, Illinois.

McCarty M. H. (2001),  The Nobel Laureates, How the world’s greatest economic minds shaped modern thought, McGraw-Hill publication. 

http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1971/

https://en.wikipedia.org/wiki/Simon_Kuznets

http://data.worldbank.org/indicator/NY.GDP.MKTP.CD?order=wbapi_data_value_2014+wbapi_data_value+wbapi_data_value-last&sort=asc

Second Nobel Prize in Economic Sciences (1970)

The Father of Modern Economics 

The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 1970 was awarded to Paul Anthony Samuelson, for the scientific work  through which he has developed static and dynamic economic theory and actively contributed to raising the level of analysis in economic science.

It was the second Nobel prize and the first Nobel prize to an American Economist. The contribution of Paul Samuelson in the field of economics is invaluable. He very delicately knitted Mathematics Analysis and Economics Analysis into Mathematical Economics. The concepts like calculus, matrices used to be esoteric before Samuelson strongly proposed them. His work in economic theory ranges from modern welfare economics, linear programming, Keynesian economics, economic dynamics, international trade theory, logic choice to maximisation. 

Paul Samuelson was born in Gary, Indiana, in 1915. He was born to a family of upwardly mobile Polish immigrants. His childhood memories were filled with the recession of 1919-21  and other major economics changes happing in the society. But in his memoir published in 2009 he wrote “I was reborn, born as an economist, at 8:00 AM on January 2nd 1932, in the University of Chicago classroom.” He got his bachelor’s degree from University of Chicago at an early age of 20, and then he joined graduate program of Harvard University. He was an outstanding student and earned Junior Fellow of the Society of Fellows, with the freedom to pursue his own research he wrote pathbreaking papers in the field of theory of consumer choice, inter temporal structure of prices and interest rates and many other areas, including his prize winning dissertation in 1941, which was later published as the landmark book Foundations of Economic Analysis in 1947.

He was appointed as an instructor at Harvard in Fall 1940, and within a month he joined as an assistant professor at MIT. He became Institute Professor in 1966, a department started as Industrial Economics to teach economics to engineers claimed the work ranking soon under the leadership of Paul Samuelson. He relentlessly contributed to the field of economics and also taught/guided economists like George Akerlof, Robert Engle, Lawrence Klein, Paul Krugman, Franco Modigliani, Robert Merton and Joseph Stiglitz who also became Nobel Laureates.

There is a lot more to say about Paul Samuelson, a lot more to say about his work, a lot more to say about his analytical skill, a lot more to say about his contribution to Mathematical Economics and a lot more to say about a person who was so complete and managed his personal life too with six kids. But I would like let others who he has influenced and who have worked with him to say about him.

George Akerlof, Nobel Prize winner, MIT PhD, Berkeley professor:

When I was at MIT in the 1960′s Paul Samuelson was far and away the leading economist in the country. He was the leading adviser to the Kennedy administration, the leading economic theorist and also the author of the leading elementary textbook.  Yet he also found time to be tremendously involved in the MIT economics PhD program.  He always kept his door open and attended such events as the department picnic.

Samuelson was also incredibly efficient, and, as students, we used to receive pink slips, which were pink memos, with some thought of his in our mailboxes.  When I wrote about his participation in the program and his interaction with all the students in a commemorative volume for him some years later, I received one of his pink slips, which said, “Thank you for the comments. I had never thought of myself as Mr. Chips.”  He may not have thought of himself that way, but of course he was.

I also remember taking a course from him where he discussed, in the spring of 1964, a long time before (Milton) Friedman and (Edmund) Phelps became famous for it, the natural rate (of employment) hypothesis.  Samuelson thought that there might be some truth to it, but thought that if it were not true that believing it would do great harm.  Governments would then keep employment low because of unfounded fears of accelerating inflation. Samuelson was way ahead of his time, not just in considering the natural rate (of employment) hypothesis, but also in appreciating that it might not be true.

Robert Lucas, Nobel Prize winner, University of Chicago Professor. (Excerpted from his memoir):

“Samuelson was the Julia Child of economics, somehow teaching you the basics and giving you the feeling of becoming an insider in a complex culture all at the same time. I loved the Foundations. Like so many others in my cohort, I internalized its view that if I couldn’t formulate a problem in economic theory mathematically, I didn’t know what I was doing. I came to the position that mathematical analysis is not one of many ways of doing economic theory: It is the only way. Economic theory is mathematical analysis. Everything else is just pictures and talk.”

Avinash Dixit, Princeton Professor, MIT PhD:

“It is indeed sad, and it is difficult to imagine the profession without him. In every decade since the 1930s he made pathbreaking contributions, any one of which would have been the pride of someone else’s whole career.

“For me it is a special bereavement. My whole style of research, and the techniques that support almost all of my own papers, derive from his foundational articles. The whole idea of modeling full equilibrium of a specific applied context lies behind my work with Joe Stiglitz on monopolistic competition and with Victor Norman on international trade. As to the techniques I learned from him and used: comparative statics of constrained optimization, the correspondence principle and the envelope theorem, factor price equalization in international trade, valuation of real options, the list could go on.”

Ben Bernanke, Federal Reserve Chairman, MIT PhD:

“Paul Samuelson was both a path-breaking and prolific economic theorist and one of the greatest teachers that economics has ever known.  I join with many other former students and colleagues of Paul’s in mourning the passing of a titan of economics.”

References:

http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1970/samuelson-bio.html

http://www.economist.com/node/15127616

http://blogs.wsj.com/economics/2009/12/13/remembering-paul-samuelson/

Dixit A. (2012), Paul Samuelson’s Legacy, Annual Reviews of Economics, Vol 4