Saturday, January 23, 2010

Small Changes In Growth Rates Add Up Over Time

In my macro courses we read a chapter in the book "The Economics of Macroissues." The chapter discussed how nations with common law systems, where property rights are better protected than in nations with civil law systems, have higher growth rates. I pointed out to my classes that even a small difference in growth rates ends up causing a very big difference in per capita incomes due to the annual compounding effect.

Paul Krugman recently mentioned that the per capita GDP since 1980 has grown 1.95% in the US and 1.83% in the EU. But we should also remember that small differences in growth rates compound over time. If per capita income was 20,000 in both the US and EU 29 years ago, the per capita income (or GDP) now would be 35,015 in the US and 33,839 in the EU, a difference of $1,176. Maybe not a big difference. But after 100 years the US income level would be 12% higher. After 200 years it would be 26% higher.

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