Growth Rates Are Crucial

In our last video, we covered the surprisingly large differences in living standards between countries. But how did we get to where we are? How did these differences come about?

Now we're going to dive into growth rates, and we're going to see how they affect prosperity. So, this graph shows real GDP per capita in the United States since 1800. But let's just give a word of interpretation. A 1% increase from a base of 100 -- that's 1. But a 1% increase from a base of 1,000 -- that's 10. So, a graph like this can make it seem as if the economy is growing at a faster and faster rate. Actually, all that's really going on here is a change in the base, in the size of the economy.

So, to handle this issue, we're going to change the graph to a ratio scale. This will help us to see growth rates a little bit more clearly. Now, each tick is a doubling. So, here we go from $1,000 to $2,000. Now, $2,000 to $4,000, and so forth. The nice thing about these graphs is that a straight line means a line of constant growth. So, for example, here's GDP per capita in the United States in 1845. It was around $2,000. Thirty-five years later, in 1880, it had doubled to $4,000. So, we know immediately, right, from the Rule of 70 that the growth rate over this period was about 2% per year. So, the lesson from this graph is that the most basic reason that the United States is wealthy is simply that it's grown consistently for a long period of time.

We can also use this graph to do something neat. We can look at other countries today and place them in U.S. history. For example, here's Bangladesh and Uganda, both of which have a real GDP per capita today, which is about the same as the United States had in 1800. Here's India. The real GDP per capita today -- about the same as the United States had in 1880. Here's China -- about the GDP per capita of the United States during the Roaring '20s. But remember, India and China -- they're growing really rapidly.

So, anything I say today is going to be a little bit off tomorrow -- they're catching up. Here's Italy. It has a GDP per capita today, which is about what the United States had around 1980. I remember 1980. I got an Atari. It was pretty good. Life was good. So, life in Italy is pretty good. Of course, these comparisons -- they're imperfect. One reason is especially interesting. Every country in the world today has a greater life expectancy than even the richest countries had in 1800. And that's because poor countries have benefited from spillovers from growth in the rich countries -- things like the eradication of diseases, like smallpox, the creation of antibiotics, improvements in the scientific understanding of sanitation.

So, even countries which haven't grown in GDP per capita -- they are a lot better off in other ways because of spillovers from the rich countries. So, these comparisons, yeah, they're imperfect. But I do think they can still give us some intuition for living standards in other countries, and also for how steady growth improves living standards. So, real GDP per capita in the United States -- it's doubled about every 35 to 40 years. And over several generations, it's this steady growth, which results in monumental increases in the standard of living. If things had been different, if the United States had grown more slowly, for example -- suppose it had grown by, let's say, 1% per year since 1800 -- then GDP per capita today would be much lower, about what we had in 1940.

Now remember, in 1940, hardly anybody has a car, they're just getting out of the Great Depression, they're about to go to war, World War II, no televisions. People in 1940 were pretty poor. In fact, the average person in 1940 had an income that today would put them below the poverty level. On the other hand, if the growth rate had been higher, suppose it had been 3% per year, then we would've hit our current living standards in 1917. And if we'd continued at that rate, then today we'd have a real GDP per capita level of $893,000. That would've been pretty nice!

At current rates of growth, we're going to have to wait until 2159 before we hit that level. I'm probably not going to make it, unfortunately...unless of course, we can find some way of increasing our growth rate. So, the lesson here is clear. It's that even small changes in growth rates -- they have really big effects when they're sustained over time. You might wonder, "Why did it take so long for growth in real GDP per capita to really get going?

Why didn't it happen before the 1800s? You know, why didn't the Industrial Revolution, why didn't it happen in 1200 or 1200 B.C. for that matter?" That's a really important question. And in our next video from Everyday Economics with Don Boudreaux, he's going to take a look at some of the potential answers and some of the mysteries behind that deep and important question.