Page 524 - The Principle of Economics

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PART NINE
THE REAL ECONOMY IN THE LONG RUN
The next chapter examines in more detail how the economy’s financial mar- kets coordinate saving and investment. It also examines how government policies influence the amount of saving and investment that takes place. At this point it is important to note that encouraging saving and investment is one way that a gov- ernment can encourage growth and, in the long run, raise the economy’s standard of living.
To see the importance of investment for economic growth, consider Figure 24-1, which displays data on 15 countries. Panel (a) shows each country’s growth rate over a 31-year period. The countries are ordered by their growth rates, from most to least rapid. Panel (b) shows the percentage of GDP that each country devotes to investment. The correlation between growth and investment, although not perfect, is strong. Countries that devote a large share of GDP to investment, such as Singapore and Japan, tend to have high growth rates. Countries that devote a small share of GDP to investment, such as Rwanda and Bangladesh, tend to have low growth rates. Studies that examine a more comprehensive list of coun- tries confirm this strong correlation between investment and growth.
There is, however, a problem in interpreting these data. As the appendix to Chapter 2 discussed, a correlation between two variables does not establish which variable is the cause and which is the effect. It is possible that high invest- ment causes high growth, but it is also possible that high growth causes high
South Korea Singapore Japan Israel Canada Brazil West Germany Mexico United Kingdom Nigeria United States India
South Korea Singapore Japan Israel Canada Brazil West Germany Mexico United Kingdom Nigeria United States India
(a) Growth Rate 1960–1991
(b) Investment 1960–1991
Bangladesh Chile Rwanda
Bangladesh Chile Rwanda
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Growth Rate (percent)
0 10 20 30 40
Investment (percent of GDP)
GROWTH AND INVESTMENT. Panel (a) shows the growth rate of GDP per person for 15 countries over the period from 1960 to 1991. Panel (b) shows the percentage of GDP that each country devoted to investment over this period. The figure shows that investment and growth are positively correlated.
Figure 24-1