Page 23 - FINAL CFA II SLIDES JUNE 2019 DAY 4

LOS 12.e: Forecast potential GDP based on READING 11: CURRENCY EXCHANGE RATES: UNDERSTANDING EQUILIBRIUM VALUE
growth accounting relations.

MODULE 12.2: GROWTH ACCOUNTING AND INFLUENCING FACTORS

The growth accounting equation is also useful in determining the comparative effects of increasing different inputs. If labor growth
accounts for the majority of economic growth, for example, analysts should be concerned with a country’s ability to continue to
increase its labor force. The relation can also be used to estimate potential output, as illustrated in the following example.

EXAMPLE: Estimating potential GDP growth rate: Azikland is an emerging market economy where labor cost accounts for 60% of total
factor cost. The long-term trend of labor growth of 1.5% is expected to continue. Capital investment has been growing at 3%. The country
has benefited greatly from borrowing the technology of more developed countries; total factor productivity is expected to increase by 2%
annually. Compute the potential GDP growth rate for Azikland. ∆Y/Y = ∆A/A + α×(∆K/K) + (1−α)×(∆L/L)

Answer: growth rate in potential GDP = 2% + (0.4)(3%) + (0.6)(1.5%) = 4.1%

Another approach is the labor productivity growth accounting equation:
growth rate in potential GDP = long-term growth rate of labor force + long-term growth rate in labor productivity

The long-term growth rate in labor productivity reflects both capital deepening and technological progress.

LOS 12.f: Explain how natural resources affect economic growth and evaluate the argument that limited availability of natural resources
constrains economic growth.

In some instances, countries with abundant natural resources (e.g., Brazil) have grown rapidly. Yet other countries (e.g., some of the
resource-rich countries of Africa) have not. Conversely, some resource-poor countries have managed impressive growth. Why?

• Access to natural resources does not require ownership of resources (Japan)
• Other theories contend that ownership of natural resources may actually inhibit growth, because the economic energy of a country rich in
natural resources may be focused on recovering those resources rather than developing other industries.
• Furthermore, countries that own valuable resources can find their currency appreciating as the demand for those resources increases
(“Dutch disease”: global demand for a country’s natural resources drives up the country’s currency values, making all exports more
expensive and rendering other domestic industries uncompetitive in the global markets.