Economic Growth
by Paul M. Romer
(From The Concise Encyclopedia of Economics, David R. Henderson, ed. Liberty Fund,
2007. Reprinted by permission of the copyright holder.)
Compound Rates of Growth
In the modern version of an old legend, an investment banker asks to be paid by
placing one penny on the first square of a chess board, two pennies on the second
square, four on the third, etc. If the banker had asked that only the white squares be
used, the initial penny would have doubled in value thirty-one times, leaving $21.5
million on the last square. Using both the black and the white squares would have
made the penny grow to $92,000,000 billion.
People are reasonably good at forming estimates based on addition, but for
operations such as compounding that depend on repeated multiplication, we
systematically underestimate how quickly things grow. As a result, we often lose
sight of how important the average rate of growth is for an economy. For an
investment banker, the choice between a payment that doubles with every square on
the chess board and one that doubles with every other square is more important
than any other part of the contract. Who cares whether the payment is in pennies,
pounds, or pesos? For a nation, the choices that determine whether income doubles
with every generation, or instead with every other generation, dwarf all other
economic policy concerns.
Growth in Income Per Capita
You can figure out how long it takes for something to double by dividing the growth
rate into the number 72. In the 25 years between 1950 and 1975, income per capita
in India grew at the rate of 1.8% per year. At this rate, income doubles every 40
years because 72 divided by 1.8 equals 40. In the 25 years between 1975 and 2000,
income per capita in China grew at almost 6% per year. At this rate, income doubles
every 12 years.
These differences in doubling times have huge effects for a nation, just as they do
for our banker. In the same 40-year timespan that it would take the Indian