16 Economic Growth
Factors for Economic Growth
Now we are going to look at what factors matter for economic growth. Real GDP grows when the quantities of the factors of production grow or when persistent advances in technology make them increasingly productive. Our standard of living improves only if growth occurs because of increases in labor productivity. (1)
Labor Productivity
Labor productivity is the quantity of real GDP produced by one hour of labor.
Labor productivity = (Real GDP) ÷ (Aggregate hours worked)
Real GDP = (Aggregate hours worked) x (Labor productivity)
Note: Using the rearranged formula shows that growth in Real GDP can be divided into growth in aggregate hours worked and growth in labor productivity.
Recall,
Growth (A x B) is approximately = Growth A + Growth B
The growth of labor productivity is influenced by saving and investment in physical capital, expansion of human capital, and discovery of new technologies. More saving and investment in physical capital increases labor productivity. The law of diminishing returns states that if the quantity of capital is small, an increase in capital brings a large increase in production; and if the quantity of capital is large, an increase in capital brings a small increase in production. This fact about capital means that saving and investment in additional capital will not bring sustained economic growth without an accompanying expansion of human capital and technological change.
- Expansion of human capital : Human capital is the accumulated skills and knowledge of people. Human capital is the most fundamental source of economic growth because it directly increases labor productivity and is the source of the discovery of new technologies. Human capital comes from education and training, job experience, and health and diet.
- Discovery of new technologies : New technologies increase labor productivity. Often these new technologies require new and better capital, such as personal computers replacing typewriters. (1)
Economic Growth Theories: Old and New
Old Growth Theory
An old growth theory is the classical growth theory . This theory predicts that the clash between an exploding population and limited resources will eventually bring economic growth to an end. According to this theory, labor productivity growth will increase real GDP per person above the subsistence level, which will bring a population explosion. Eventually, the population growth will decrease capital per worker hour and labor productivity will fall and real GDP per person will return to the subsistence level. Malthusian theory is another name for classical growth theory — named after Thomas Robert Malthus . Malthus predicted that population growth would result in people having a primitive standard of living at the subsistence level of real GDP per person. (1)
New Growth Theory
New growth theory is the theory that our unlimited wants will lead us to ever greater productivity and perpetual economic growth.
The new gro