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Lesson M08.L01: Long-Run Economic Growth: Facts and Patterns

Module: The Economy in the Long Run: Introduction to Economic Growth Level: intro Duration: 30 minutes Learning Objective: Describe the key stylised facts of long-run economic growth. Data as of: 2023 Provenance: ABS | RBA | OpenStax Macro 3e

Explanation

Long-run economic growth refers to the sustained increase in an economy's productive capacity — and hence real GDP per capita — over decades. It is distinct from short-run fluctuations (recessions and booms). While recessions feel dramatic, it is long-run growth that determines living standards across generations.

Key stylised facts of long-run growth:

  1. Small differences in growth rates compound dramatically. An economy growing at 1% per year doubles in roughly 70 years. An economy growing at 3.5% per year doubles in just 20 years (the Rule of 70: years to double ≈ 70 ÷ growth rate).

  2. Growth rates vary significantly across countries. East Asian economies (South Korea, Taiwan, Singapore) achieved sustained growth of 6–8% per year over 1960–2000, transforming from low-income to high-income in a single generation. Sub-Saharan African economies averaged much lower rates.

  3. Australia's long-run growth has been remarkably consistent. Australia has not experienced a recession for 29 consecutive years (1991–2020), the longest streak in the developed world. Real GDP per capita grew at approximately 1.5–2% per year on average over recent decades (ABS National Accounts).

  4. Growth tends to slow as countries get richer (conditional convergence). Poor countries with little capital can achieve rapid growth; rich countries with large capital stocks face diminishing returns.

  5. Technology (Total Factor Productivity, or TFP) is the dominant driver of sustained growth in the long run. Physical capital accumulation alone cannot sustain growth indefinitely due to diminishing returns.

The Rule of 70 is a simple tool: divide 70 by the annual growth rate to estimate how many years it takes for GDP (or GDP per capita) to double.

Worked Example

Comparing two economies using the Rule of 70:

Economy A (Australia-like): real GDP per capita grows at 2.0% per year
Economy B (fast-growing): real GDP per capita grows at 5.0% per year

Economy A doubling time:
Years to double = 70 ÷ 2.0 = 35 years

Economy B doubling time:
Years to double = 70 ÷ 5.0 = 14 years

Now project forward from a base of $60,000 GDP per capita (roughly Australia's 2023 level in AUD):

Economy A after 70 years (two doublings):
Year 0: $60,000
Year 35: $60,000 × 2 = $120,000
Year 70: \(120,000 × 2 = **\)240,000**

Economy B after 70 years (five doublings):
Years to double at 5% = 14 years → 70 ÷ 14 = 5 doublings
Year 0: $60,000
After 5 doublings: $60,000 × 2⁵ = \(60,000 × 32 = **\)1,920,000**

Difference after 70 years:
$1,920,000 − \(240,000 = **\)1,680,000 per capita**

A 3-percentage-point difference in the annual growth rate produces an 8-fold difference in living standards over 70 years. This illustrates why even small differences in growth rates matter enormously in the long run.

Common Misconception

Misconception: A country that grows at 3% this year is twice as well off as one that grows at 1.5%, because the growth rate is double.

Correction: This confuses the rate of change with the level of GDP. Both countries are growing — the 3% country is growing faster, not producing twice as much. The real impact of a higher growth rate only becomes apparent over many decades through compounding. In year one, a $2 trillion economy growing at 3% gains $60 billion; one at 1.5% gains $30 billion. But over 70 years, the compounding effect is transformative (as shown in the worked example above).

Practice Prompts

  1. Australia's real GDP per capita grew at approximately 1.5% per year over the past two decades. Using the Rule of 70, how long would it take to double? → Answer: Years to double = 70 ÷ 1.5 ≈ 47 years.

  2. Why do economists focus on real GDP per capita rather than total real GDP when comparing living standards across countries? → Answer: Total GDP rises when population grows, even if each person is no better off. Real GDP per capita (GDP divided by population) measures output per person, giving a better indication of average living standards. "Real" removes the distortion of inflation.

  3. Name one reason why long-run growth tends to slow as a country becomes richer. → Answer: Diminishing marginal returns to capital — as a country accumulates more physical capital (machines, buildings, infrastructure), each additional unit of capital adds less and less to output. Rich countries with large capital stocks therefore find it harder to sustain rapid growth through capital accumulation alone.

Further Resources