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86 Labor Productivity and Economic Growth
Learning Objectives
Describe factors that contribute to labor productivity
Analyze the sources of economic growth using the aggregate production function
Labor Productivity and Economic Growth
Sustained long-term economic growth comes from increases in worker productivity, which essentially means how well we do things. In other words, how efficiently does a nation use its workers and other resources? Labor productivity is the output that each employed person creates per unit of his or her time. The easiest way to understand labor productivity is to imagine a Canadian worker who can make 10 loaves of bread in an hour versus a U.S. worker who in the same hour can make only two loaves of bread. In this fictional example, the Canadians are more productive. Being more productive essentially means you can do more in the same amount of time. This in turn frees up resources to be used elsewhere.
What determines how productive workers are? The answer is pretty intuitive. The main determinants of labor productivity are physical capital, human capital, and technological change. These can also be viewed as key components of economic growth.
Physical capital can be thought of as the tools workers have to work with. More formally, physical capital includes the plant and equipment used by firms but also infrastructure, things like roads and other components of transportation networks that contribute to the economy. Infrastructure is provided by governments. Again, greater physical capital implies more output. Physical capital can affect productivity in two ways: (1) an increase in the quantity of physical capital (for example, more computers of the same quality); and (2) an increase in the quality of physical capital (same number of computers but the computers are faster, and so on). Human capital is the accumulated knowledge (from education and experience), skills, and expertise that the average worker in an economy possesses. Typically the higher the average level of education in an economy, the higher the accumulated human capital and the higher the labor productivity. Human capital and physical capital accumulation are similar: in both cases, investment now pays off in longer-term productivity in the future.
Another factor that determines labor productivity is technology. Technological change is a combination of invention—advances in knowledge—and innovation, which is putting that advance to use in a new product or service. For example, the transistor was invented in 1947. It allowed us to miniaturize the footprint of electronic devices and use less power than the tube technology that came before it. Innovations since then have produced smaller and better transistors that that are ubiquitous in products as varied as smart-phones, computers, and escalators. The development of the transistor has allowed workers