Modern economic growth refers to the rapid economic growth of the past two centuries following the industrial revolution.
Factors to economic growth include the rule of law, property rights, and contractual rights.
Labor and Economic Growth
Labor productivity refers to the ability of a specialized worker to produce more or faster, allowing others to focus on other things, as explained by Adam Smith in Wealth of Nations.
Productivity is determined by:
- Human capital - knowledge and expertise of the average worker in an economy
- Technological change - invention (advances in knowledge) and innovation (applying advances)
- Economies of scale - the ability to lower costs by producing more
Measures of Growth and Productivity
Production functions describe how inputs are turned into outputs.
The aggregate production function can be described in terms of GDP or GDP per capita as its output, as a measure of economic growth.
The Aggregate Production Function
GDP
Workforce, Human capital, Physical capital, Technology GDP
GDP per capita
Human capital per person, Physical capital per person, Technology per person GDP per capita
Rates of productive growth correlate strongly with the growth rate of GDP per capita, but are not identical. Consider a situation where workforce participation increases, and thus GDP per capita. The average worker’s productivity would remain unchanged.
GDP per capita may increase over the long term only if average worker productivity rises, or if capital increases.
Productivity per worker may be measured in terms of dollar value per hour, adjusted for inflation. Wages are related to productivity growth, as employers pay the value of their employees’ production.
Compounding Economic Growth
To make a simple calculation of future GDP:
Components of Growth
Physical capital is used in production, including infrastructure.
Human capital is the human knowledge and experience used in production.
Technology includes the techniques and ideas used in production.
Capital Deepening
Capital deepening is the result of increasing capital per person, applying to both human and physical capital. Human capital may be measured by average education level.
Growth Accounting
Economists study the extent to which human and physical capital affects economic growth by applying an aggregate production function. The residual, which cannot be explained by capital, is attributed to technology.
Economic Convergence
Certain low and middle-income economies have recently grown at much faster rates compared to high-income countries, showing a pattern of convergence.
According to the law of diminishing marginal returns, a nation with low levels of education have more to gain in terms of human capital when education increases.
However, with improvements in technology, more can be produced given the same set of capital inputs. Low-income economies may be able to more easily copy technologies from high-income economies, which must invent new technologies to see benefits.
Economic convergence happens slowly, as wealthy nations see the compounding effects of starting with a higher GDP.