(Economics 100b; Spring 1996)
January 19, 1996 [originally scheduled for January 17, 1996;
postponed due to chicken pox]
Who I Am
Who You Are
Long-Run Growth and Business Cycles
What We Are Going to Do This Semester
We are meeting now, Friday, rather than then--last Wednesday--because
I have the chicken pox. Let me urge you to get any children you have
or may have in the future vaccinated--or at least exposed--to the
chicken pox when they are relatively young: adult-onset chicken pox
is a much less friendly disease than is childhood chicken pox. Let me
reassure you that the doctors say that I am no longer contagious. And
let me apologize: this course is still "looser," in terms of
organization and in terms of how it has jelled in my mind than I
would want it to be.
Who I Am
I am Brad DeLong. This is my first year here at Berkeley as an
Associate Professor in the Economics Department. For the previous two
and a half years I worked in Washington, as part of Laura Tyson's
decimation of the Berkeley economics department to staff the Clinton
Administration. In fact, we just lost another one last December:
industrial organization economist Joe Farrell went on leave to become
Chief Economist at the Federal Communications Commission. We still
have somewhere between five and ten economist in Washington.
When you wonder at the number of economics courses that are
mysteriously not being offered, reflect on the fact that the Berkeley
powers-that-be allocate about one-fifth of the salary of the
professors on leave back to the department to hire visitors: if we
have ten people on leave in Washington, the powers-that-be allocate
us enough money to hire two visitors. Not a good situation.
But I am back. And I may be the best person at Berkeley to teach this
course because of what I did in Washington. Most of my job there--as
Deputy Assistant Secretary of the Treasury for Economic
Policy--was the subject matter of this course: business
cycles, inflation, effect of economic policies on the stability of
the economy, determinants of long-run growth and income distribution,
effect of economic policies on long-run growth, and on income
distribution. What is for you the subject matter of a course was, for
me, the principal component of my job for two and a half years.
Who You Are
About one-third of you should be economics majors...
- A final exam
- Two "midterms" (March 8 and April 17)
- About ten problem sets--which can only improve your grade...
The "Black Lightning" people have asked permission to take and
distribute lecture notes for this course. Talking to other faculty I
get two streams of advice. The first is "no"--that the Black
Lightning people have not been competent and thus that the notes
produced in the past have been incoherent. You take a ten percent hit
on lecture attendance if you let the Black Lightning system establish
itself; and the ten percent who do not attend are the ten percent who
need to attend, and who are very badly served by trying to
puzzle it out afterwards from incoherent lecture notes.
The second stream of advice is "yes"--it provides money to buy pizza
for us professors and teaching assistants during the grading
marathons that take place in a course like this one. You are adults.
Economists believe in enhancing choice--that giving extra options to
responsible adults who understand their situation can never be bad,
and that people who choose to sleep through the lecture and try to
catch up afterwards from notes have good reasons for choosing to do
So what I am going to do is to deny Black Lightning permission to
make and redistribute notes, but to put my own lecture notes up on
the world wide web, at:
and the associated sub-pages. The bad will be that you will have to
read them off the computer using something like Netscape. (Or print
them out.) The good is that I cannot complain about their inaccuracy
or incoherence should you rely on them. And that they are free.
If demand for Econ 100b notes via the internet turns out to be
unexpectedly high, my world wide web server may begin to choke and
die, in which case I will move everything over to a more powerful
computer like the Economic Department's Emilies. So problems
obtaining internet access--I want to know about them as fast as
Long-Run Growth and Business Cycles
This chart shows U.S. real GDP per worker in 1995 prices over the
past century. Let's unpack the chart title, because there is a lot
going on in it: "U.S." and "1890-1995" are relatively
straightforward. "GDP" is an abbreviation for gross domestic
product. "Gross" means that we are not correcting for
depreciation--the reduction in value of economic capital as it slowly
wears out and approaches the end of its useful life. Four years ago
my wife and I got a Volvo station wagon costing some $22,000. Today
the current value of this station wagon is only $11,000--four years'
worth of wear-and-tear that have brought it four years closer to the
end of its useful life have also reduced its economic value by half.
- Measures of net economic product correct for
depreciation--calculate, for example, that a factory producing X
during the year didn't really produce X but instead only X-Y,
because the process of production put Y worth of wear-and-tear on
the factory's capital stock.
- Measures of gross economic product do not correct for
depreciation. Measures of net product are, conceptually,
better--but they are very hard to do, the people at the Commerce
Department's Bureau of Economic Analysis who create these numbers
have little confidence in the accuracy of their depreciation
estimates, and they prefer to focus on numbers they think they can
measure adequately--even if it is not quite the concept they would
ideally like to measure.
"Domestic" means that we are looking at all marketed and
government production taking place inside the boundaries of the
United States. We don't care that New York's Rockefeller Center is
owned by people who live in Japan--the services provided by
Rockefeller Center to those who rent office space there, and the
income generated by the rental are part of domestic product.
Conversely, income generated abroad by factories located in Malaysia
owned by U.S. citizens does not enter into domestic product.
- The alternative concept, "national" product, would
include products made and income generated by extra-U.S.
property owned by U.S. citizens, and would exclude products
made and income generated by property in the U.S. that was owned
by non-U.S. citizens. We now use domestic product because our
estimates of cross-border income and profit flows are riddled with
error, and thus our estimates of national product are of
signficantly lower quality than our estimates of domestic
"Product." Finally, a noun. The economic product of a
country, a region, an individual is the market value of goods and
services produced over the course of a year. For example, my mother
the psychologist "produces" some $80,000 of therapy each year. She
works. Patients feel better and more well-adjusted--and find it
worthwhile to pay her, or their insurance companies do. That $80,000
is her income, and it is also value-added for the economy as a whole:
something produced over the course of a year which consumers were
willing to pay for.
"Real" and "(1995 Prices)". Measured economic product could change
because the volume of economic activity changed, or it could change
because the prices at which goods and services sell changed--either
because of general inflation or deflation, or because of shifts in
relative prices. We want to ignore shifts in measured economic
product caused by shifts in the price level. So we look at
real GDP at 1995 prices. The idea is to take a
representative slice of what was produced at some other date, and ask
"what would this sell for if we brought it forward in time to 1995?"
This way we manage to--imperfectly--control for shifts in price
levels and in relative prices. Seasonal adjustment you do not have to
worry about yet.
"Per Worker." Real GDP is a measure only of economic activity that
passes through the market--is bought or sold (with a few exceptions).
Within-the-household-production is counted in GDP if it is bought or
paid for, and if not, is not. As the share of the American adult
population in the paid labor force has risen, so measured GDP has
risen even though part of what has been going on has been the
shifting boundary between categories of work that used to be outside,
but are now inside the market. So we divide real GDP by the size of
the American labor force to attempt to control for the
shifting boundary between market and non-market work, and also to
control for the overall growth of population. So there is the
unpacked title of the graph. It is a measure of the average
productivity, controlling for inflationary and deflationary shifts in
the price level, of the American labor force.
"Average" in the sense that we have taken the market value of all
goods and services produced in the U.S. and divided by the number of
workers. It is a gross measure in that it doesn't take account
of depreciation and capital consumption--the fact that this year's
production has placed wear-and-tear on the nation's accumulated
capital stock. When we look at this graph, what do we see? It has
gone up a lot over the past century. In 1890, real GDP per worker (at
1995's prices) was only some $12,000 a year. Take what the average
worker produced in 1890, bring it forward in time to 1995, and sell
it--and you will get some $12,000 for it. By contrast, real GDP per
worker crossed $50,000 a year sometime early in this decade, and
continues to rise.
- It would not be a mistake to say, roughly, that we today are
at least 4.5 times as well-off as our predecessors who
lived in the U.S. in 1890. In fact, the factor of 4.5 is almost
surely an underestimate. We can today purchase or use a much
broader range of goods and services than people could in 1890,
real GDP measures take no account of the extra welfare produced by
an enhanced range of choice among different types of commodities.
The work year has also dropped from perhaps 2400 hours a year on
average then to perhaps 1800 hours a year on average now.
- Make your guesses as to how much the expanded range of
capabilities and powers produced over the past century--as opposed
to increased quantities of things we knew how to make a century
ago--has contributed to your welfare, and adjust for the declining
workweek, and come up with estimates that range from my favorite
of 10 to as high as 30 for the multiplication of the average
productivity of the American worker over the past century.
- So the first thing to note is that there has been an enormous
amount of economic growth over the past century. And we are going
to spend some time decomposing that growth into its various
sources and causes this semester.
The second thing to
notice is that the pace of growth is not all that smooth:
- The economy falls off of a cliff at the end of the 1920s--the
- Mobilization for World War II sees a steep increase that is
not sustained at the end of the war as shifts shrink back from 12
to 8 hours and as government demand for the heavy industrial
materials of modern war falls.
- The first generation after World War II sees rapid growth--the
Korean War Boom, the boom of the 1960s.
- The second generation after World War II sees relatively slow
growth--in the 1970s product per worker comes close to stagnating,
and the 1980s did not see a bounce-back to make up any of the lost
ground. When people talk of the "productivity slowdown" they are
talking of the bend in this real GDP per worker curve at the end
of the 1960s that separates the first, fast-growth post-World War
II generation from the more recent, slow-growth period.
The third thing to notice is that the graph has wiggles. These
wiggles are this country's "business cycles": expansions and
recessions, episodes of rising and falling unemployment, and so
- These business cycles have less of an impact on the country's
overall economic welfare than does the secular tide of rising
incomes and productivity traced over the whole century; they have
less of an impact than do the episodes of productivity speed-up
and slow-down seen in comparisons of pre- to post-1970 experience.
- But these business cycles--the little wiggles--are the
major source of uncertainty over the one-to-ten year span
of time that most of us plan for. And these business cycles are
also the most clearly affected and influenced by government
policy. So we will spend most of our time on them.
- Moreover, the business-cycle-wiggles have much more important
consequences for economic welfare than they do for economic
activity because of the correlation between business-cycle swings
in output and swings in unemployment.
- Why does a given business-cycle swing--a fall of, say, five
percent in output relative to the long-run potential growth path
of the American economy--have such big effects on economic
- Because the distribution of the costs of
unemployment--and thus of the business cycle--is so unequal.
- One of the major presumptions of this course is that
business-cycle fluctuations are, in a sense, very odd--much bigger
than you would expect given the "normal" workings of a market
economy as a social calculating mechanis for deciding what and how
much to produce.
- Note, once again, the centrality of the Great
Depression in our experience over the past century. We would
all sleep much, much easier if you could guarantee that nothing
like the Great Depression will ever come again.
The other major feature of the macroeconomy that you read about in
the newspaper is inflation:
Inflation upsets a lot of people a lot more than most economists
think that it should:
- Feeling that measuring rods are unstable.
- Feeling that the income "lost" as a result of high inflation
is a loss of real income.
- Consequences of high inflation are bad enough: deranging the
price mechanism; lots of windfall gains and losses; difficulty in
persuading people that the burst of inflation has come to an end.
What We Are Going to Do This Semester
- Two weeks on the economy in "equilibrium"
- A section on domestic economic policy, and business cycles
- A section on the international dimension.
- A section on long-run growth.