Productivity and Economic Growth

Productivity and Economic Growth

• Economic growth correlates directly with increased productivity.
• For economic growth to occur, there must be an increased production of goods and services within a nation.
• Economic growth necessitates increases in real GDP.
• Increased production of goods and services requires greater employment of the main factors of production.
• The possibilities for increased production are: additional labor added to the existing capital stock; more capital employed and more labor hired; and more capital, land, and labor employed
• More salaries and wages flow to hoseholds
• More profit/rent is generated for the households providing increased levels of K (capital) and T (land)
• Greater overall national affordability of goods/services results from increased availability and affordability of goods/services.
• An overall increase in national welfare (national well-being) is reflected by an overall enhanced standard of living.
• Increases in a nation's overall standard of living are linked to economic growth.
• Economic growth is further characterized by: greater production levels (higher real GDP), greater employment of capital and land, and more jobs created with greater employment of labor
• Enhanced national welfare is characterized by increased overall availability and affordability of goods/services.
• A country's standard of living hinges on its ability to produce goods/services.
• National welfare depends upon a nation's productive capacity.

Measuring Productivity

• A nation's productive ability relies on labor productivity
• Labor productivity is the average quantity of goods/services produced per unit of labor input.
• Y = real GDP = quantity of output produced.
• L = quantity of labor.
• Labor productivity = Y/L (output per worker)

Impact of Productivity

• A nation's workers being productive means a nations' real GDP is high
• The result is high incomes for workers
• Productivity increases result in higher living standards.

Determinants of Productivity and Economic Growth

• Factors determine the degree of a nation's productivity, and corresponding economic growth.

Physical Capital

• Capital is the plant and equipment
• Denoted by K
• The stock of equipment, machines, and tools used to produce goods and services, is known as physical (or economic) capital.
• Productivity is higher when the average worker has more capital (machines, equipment, etc.) to use.

Human Capital

• Human capital (H) represents the knowledge and skills workers acquire through education, training, and experience.
• H/L = average worker's human capital.
• Higher productivity is achieved when the average worker has more education and skills.
• Increased human capital causes an increase in output per worker

Natural Resources

• Natural resources (N) are the inputs into production provided by nature.
• Examples: fertile land, mineral deposits, and waterways.
• Using more natural resources allows a country to produce more real GDP
• An increase in natural resources per worker results in increased output per worker
• Some countries are wealthy because they have abundant natural resources, for example Saudi Arabia has lots of oil
• However, some countries do not need to have much N to be wealthy: Japan imports the natural resources it needs.

Technological Knowledge

• Consists of the production technology and technological knowledge or society's understanding of the best ways to produce goods and services.
• Any advance in knowledge that boosts productivity.
• Technological knowledge generates more output from a nation's resources.
• Example: Henry Ford and the automobile assembly line.

Tech. Knowledge vs. Human Capital

• Technological knowledge is society's understanding of how to produce goods and services.
• Human capital results from the effort people expend to acquire this knowledge.
• Both are important for productivity.

Production Function

• The production function shows input and outputs
• Y = A F(L, K, H, N)
• F: Inputs (L, K, H, N) combined to produce output (Y).
• A = Level of technology.
• Improvements in technology allow more output to be produced with a given combination of inputs.
• Production functions have constant returns to scale.
• Changing all inputs by the same percentage causes output to change by that percentage.
• Multiplying each input by 1/L then output is multiplied by 1/L.

Policies for Growth

• Increase in output per worker can come from: increases in capital and/or human capital
• Increasing capital comes from investment
• Human capital increases from investment as well
• Change in A can come from technological change; innovation, creation of new goods and new processes.
• A society impacts the growth performance of an economy by: affecting capital, human capital, technology.
• A society can affect these factors through public policy.
• Public policy can long-run growth in productivity and living standards.

Economic Growth and Public Policy

• Saving S and Investment I in a nation boosts productivity.
• Saving comes with reducing consumption
• Savings can fund the production of investment goods
• Therefore, a trade-off exists between current and future consumption.

Investment from Abroad

• Raising the capital per worker ratio raises productivity, wages, and living standards, a government can utilize investment from abroad
• Foreign direct investment (capital investment such as a factory) is owned and operated by a foreign entity
• Foreign portfolio investment is a capital investment financed with foreign money, but operated by domestic residents.
• Investment from abroad is especially beneficial in low-income countries that cannot generate enough savings to fund investment projects
• Also, investment from abroad helps low-income countries learn state-of-the-art technologies in other countries.

Education

• Governments increases productivity by promoting education.
• Education is investment in human capital that increases knowledge and skills of the population.
• Public policy to promote investment in human capital: includes public (state) schools and subsidized loans for college or university.

Health and Nutrition

• Health care expenditure is a type of investment in human capital and therefore makes workers more productive.
• Raising workers' caloric intake raises productivity in countries with significant malnourishment.

Historical Significance

• Over 1962-95, caloric consumption rose 44% in S. Korea, and economic growth was spectacular.
• Nobel winner Robert Fogel showed that 30% of Great Britain's growth from 1790-1980 was due to improved nutrition.

Rule of Law, Political Stability and Property Rights

• Rule of law, political stability and property rights are basic conditions to have a stable/well functioning economy.
• Absence of these conditions creates uncertainty about the future, and worsen(s) investment climate/growth prospects.
• Sustained productivity requires respect for property rights: the ability of people to exercise authority over the resources they own.
• Due to the justice system not working well, these things are problems: contracts aren't always enforced; Fraud, corruption often goes unpunished; Firms must bribe government officials for permits.
• Political instability creates uncertainty over whether property rights will be protected currently, and/or in the future.
• When people fear their capital may be stolen by criminals or confiscated by a corrupt government, there is less investment.
• Economy functions les efficiently
• Result: Less productivity and lower living standards.
• Law enforcement, stable constitution, and institutions that create transparency in administration are important

Free Trade

• International trade contributes to increased productivity, growth and higher standard of living through: better use of resources, increased competition, business dynamism and new opportunities for investment.
• Two types of trade policies exist: inward and outward oriented
• Inward-oriented policies limit international trade
• Outward-oriented policies expand international trade

Trade example

• Country A: large amount/high fertility land for agriculture= low cost wheat producer
• Country A: No iron ore with a lack of tech to extract= high cost steel producer
• Country B climate and land that isn't good for agriculture = high cost wheat producer
• Country B: large iron ore and suitable production for steel= low cost steel production
• Mutual benefits for both countries as a low-cost wheat producer

Effect of Trade

• Trade improves productivity by leading firms to innovate and create new products and services for Research and Development (R&D).
• It reduces unit costs and increases productivity.
• Trade expands the size of the market
• Trade is like discovering new technologies and improves productivity and living standards.
• Countries with inward-oriented policies have generally failed to create growth: Argentina during the 20th century is one example.
• Countries with outward-oriented policies have often succeeded for example South Korea, Singapore, Taiwan after 1960.

Research and Development

• Tech. progress is the main reason why living standards rise over the long run.
• One reason is that knowledge is a public good: share freely, increasing productivity of many.
• Public policies to promote tech. progress, is tax incentives/direct support, granting basic research at universities, and patent laws.

Population Growth

• Can affect living standards in three different ways: stretching natural resources, diluting the capital stock and promoting tech. progress
• Diluting of capital stock= greater strain on educational system.
• Smaller countries tend to be more successful at avoiding the adverse effects of larger population growth
• A common method to control to combat growth= China's one child per family laws
• Other methods include: Contraception education & availability, and promote female literacy
• Evidence from Michael Kremer showed the course of human history had: growth rates increased from more populate rates

Natural Resources Limit

• Some argue that population growth depletes renewable earth resources and limit growth of loving standards
• Technological progress often yields ways to avoid limit, example of the use of hybrid cars
• As resources get scarce, the market price rises, which increases the incentive to conserve and develop alternatives.

Final words

• In the long run, national welfare and living standards are determined by productivity.
• Policies that affect the determinants of productivity affects the next generation's living standards.
• Determinants of productivity is saving and investment.