The Only Way Standard of Living Can Increase Is Through Increases in Labor Productivity.​
Chapter 20. Economical Growth
20.2 Labor Productivity and Economical Growth
Learning Objectives
By the terminate of this section, y'all will be able to:
- Place the office of labor productivity in promoting economical growth
- Analyze the sources of economic growth using the amass product function
- Measure out an economic system's rate of productivity growth
- Evaluate the ability of sustained growth
Sustained long-term economic growth comes from increases in worker productivity, which essentially means how well we do things. In other words, how efficient is your nation with its fourth dimension and workers? Labor productivity is the value that each employed person creates per unit of his or her input. The easiest style to comprehend labor productivity is to imagine a Canadian worker who can make 10 loaves of staff of life in an hour versus a U.S. worker who in the same hour can make but two loaves of bread. In this fictional instance, the Canadians are more productive. Being more than productive essentially means you can do more in the same amount of fourth dimension. This in plough frees up resources to be used elsewhere.
What determines how productive workers are? The answer is pretty intuitive. The beginning determinant of labor productivity is human upper-case letter. Human capital is the accumulated noesis (from instruction and experience), skills, and expertise that the average worker in an economy possesses. Typically the higher the average level of didactics in an economy, the college the accumulated human capital and the higher the labor productivity.
The second factor that determines labor productivity is technological change. Technological alter 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 immune u.s. to miniaturize the footprint of electronic devices and use less power than the tube technology that came earlier information technology. Innovations since then accept 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 to be anywhere with smaller devices. These devices can exist used to communicate with other workers, measure product quality or do any other job in less time, improving worker productivity.
The third cistron that determines labor productivity is economies of scale. Recall that economies of scale are the price advantages that industries obtain due to size. (Read more than about economies of scale in Toll and Manufacture Construction.) Consider again the case of the fictional Canadian worker who could produce ten loaves of bread in an hour. If this difference in productivity was due only to economies of scale, it could be that Canadian workers had access to a large industrial-size oven while the U.S. worker was using a standard residential size oven.
At present that we take explored the determinants of worker productivity, allow'southward plough to how economists measure out economic growth and productivity.
Sources of Economic Growth: The Aggregate Product Function
To analyze the sources of economic growth, it is useful to think virtually a production part, which is the process of turning economical inputs like labor, machinery, and raw materials into outputs like goods and services used by consumers. A microeconomic production function describes the inputs and outputs of a firm, or perhaps an industry. In macroeconomics, the connection from inputs to outputs for the entire economic system is called an aggregate production function.
Components of the Aggregate Product Function
Economists construct unlike production functions depending on the focus of their studies. Figure 1 presents two examples of amass production functions. In the start production office, shown in Figure i (a), the output is GDP. The inputs in this instance are workforce, human capital, physical capital, and technology. We hash out these inputs further in the module, Components of Economic Growth.
Measuring Productivity
An economy's rate of productivity growth is closely linked to the growth rate of its GDP per capita, although the two are non identical. For case, if the percentage of the population who holds jobs in an economy increases, Gdp per capita will increase but the productivity of individual workers may not exist affected. Over the long term, the only mode that Gross domestic product per capita tin grow continually is if the productivity of the average worker rises or if there are complementary increases in capital.
A common measure of U.Southward. productivity per worker is dollar value per hour the worker contributes to the employer's output. This measure excludes authorities workers, because their output is not sold in the market and so their productivity is difficult to measure. It also excludes farming, which accounts for only a relatively small share of the U.S. economy. Figure 2 shows an index of output per hour, with 2009 as the base year (when the index equals 100). The index equaled almost 106 in 2014. In 1972, the index equaled l, which shows that workers accept more than doubled their productivity since then.
According to the Section of Labor, U.S. productivity growth was adequately strong in the 1950s simply and so declined in the 1970s and 1980s before rising again in the second half of the 1990s and the first half of the 2000s. In fact, the rate of productivity measured by the modify in output per hour worked averaged 3.2% per year from 1950 to 1970; dropped to ane.9% per year from 1970 to 1990; and and so climbed dorsum to over two.3% from 1991 to the nowadays, with another modest slowdown later 2001. Effigy 3 shows average annual rates of productivity growth averaged over fourth dimension since 1950.
The "New Economy" Controversy
In recent years a controversy has been brewing among economists virtually the resurgence of U.S. productivity in the second one-half of the 1990s. One schoolhouse of idea argues that the United states had developed a "new economy" based on the extraordinary advances in communications and it of the 1990s. The nigh optimistic proponents argue that it would generate higher average productivity growth for decades to come. The pessimists, on the other hand, argue that fifty-fifty five or ten years of stronger productivity growth does not prove that higher productivity will final for the long term. Information technology is hard to infer anything about long-term productivity trends during the later office of the 2000s, because the steep recession of 2008–2009, with its sharp simply not completely synchronized declines in output and employment, complicates any interpretation. While productivity growth was high in 2009 and 2010 (around 3%), it has slowed downwards since then.
Productivity growth is likewise closely linked to the boilerplate level of wages. Over time, the amount that firms are willing to pay workers will depend on the value of the output those workers produce. If a few employers tried to pay their workers less than what those workers produced, then those workers would receive offers of college wages from other turn a profit-seeking employers. If a few employers mistakenly paid their workers more than what those workers produced, those employers would before long end up with losses. In the long run, productivity per hr is the most of import determinant of the boilerplate wage level in whatever economy. To acquire how to compare economies in this regard, follow the steps in the following Work It Out feature.
Comparing the Economies of Ii Countries
The Organisation for Economic Co-functioning and Evolution (OECD) tracks data on the annual growth charge per unit of real Gross domestic product per hour worked. You can find these information on the OECD data webpage "Labour productivity growth in the total economy" at this website.
Stride ane. Visit the OECD website given higher up and select two countries to compare.
Pace 2. On the drop-downwardly card "Variable," select "Real Gross domestic product, Annual Growth, in percent" and tape the information for the countries you have chosen for the five most recent years.
Footstep 3. Go dorsum to the drop-down carte and select "Real Gdp per Hr Worked, Annual Growth Charge per unit, in percent" and select data for the same years for which y'all selected Gross domestic product data.
Step 4. Compare real Gdp growth for both countries. Table 2 provides an case of a comparing between Australia and Belgium.
| Australia | 2009 | 2010 | 2011 | 2012 | 2013 |
| Real Gross domestic product Growth (%) | 0.1% | 1.0% | 2.two% | 0.8 | 0.7% |
| Existent Gross domestic product Growth/Hours Worked (%) | 1.9% | –0.3% | 2.iv% | 3.3% | 1.4% |
| Kingdom of belgium | 2009 | 2010 | 2011 | 2012 | 2013 |
| Real Gdp Growth (%) | –3.iv | 1.6 | 0.8 | –0.half dozen | –0.2 |
| Existent GDP Growth/Hours Worked (%) | –one.iii | –1.four | –0.5 | –0.3 | 0.3 |
| Tabular array 2. | |||||
Step five. Consider the many factors can bear on growth. For example, one gene that may take affected Australia is its isolation from Europe, which may have insulated the country from the effects of the global recession. In Belgium's case, the global recession seems to have had an affect on both GDP and existent Gross domestic product per hours worked between 2009 and 2013, though productivity does seem to be recovering.
The Power of Sustained Economic Growth
Nothing is more important for people'southward standard of living than sustained economic growth. Even pocket-sized changes in the rate of growth, when sustained and compounded over long periods of time, brand an enormous difference in the standard of living. Consider Table 3, in which the rows of the table show several different rates of growth in Gdp per capita and the columns testify different periods of time. Assume for simplicity that an economy starts with a Gross domestic product per capita of 100. The table and so applies the post-obit formula to calculate what Gdp volition be at the given growth rate in the hereafter:
[latex]GDP\;at\;starting\;date\;\times\;(i\;+\;growth\;rate\;of\;GDP)^{years} = GDP\;at\;terminate\;appointment[/latex]
For example, an economy that starts with a GDP of 100 and grows at iii% per year will reach a Gross domestic product of 209 after 25 years; that is, 100 (one.03)25 = 209.
The slowest charge per unit of Gross domestic product per capita growth in the table, only ane% per year, is similar to what the U.s. experienced during its weakest years of productivity growth. The second highest charge per unit, 3% per twelvemonth, is shut to what the U.S. economic system experienced during the stiff economy of the late 1990s and into the 2000s. Higher rates of per capita growth, such as five% or eight% per year, represent the feel of rapid growth in economies like Nihon, Korea, and China.
Table 3 shows that fifty-fifty a few percentage points of departure in economic growth rates will have a profound effect if sustained and compounded over time. For example, an economy growing at a 1% annual charge per unit over 50 years will see its Gdp per capita ascension past a total of 64%, from 100 to 164 in this instance. However, a country growing at a v% annual rate will see (well-nigh) the aforementioned amount of growth—from 100 to 163—over merely 10 years. Rapid rates of economic growth can bring profound transformation. (Encounter the following Clear It Up feature on the relationship between compound growth rates and compound interest rates.) If the rate of growth is viii%, young adults starting at historic period 20 will meet the average standard of living in their state more than than double by the time they accomplish age xxx, and grow nearly sevenfold by the time they accomplish age 45.
| Growth Rate | Value of an original 100 in 10 Years | Value of an original 100 in 25 Years | Value of an original 100 in fifty Years |
|---|---|---|---|
| 1% | 110 | 128 | 164 |
| three% | 134 | 209 | 438 |
| five% | 163 | 338 | 1,147 |
| 8% | 216 | 685 | 4,690 |
| Table three. Growth of Gdp over Different Time Horizons | |||
How are chemical compound growth rates and compound interest rates related?
The formula for growth rates of GDP over different periods of time, as shown in Figure 2, is exactly the aforementioned every bit the formula for how a given amount of fiscal savings grows at a certain involvement rate over time, as presented in Choice in a Earth of Scarcity. Both formulas take the same ingredients:
- an original starting corporeality, in one case Gdp and in the other case an amount of financial saving;
- a percentage increase over time, in ane instance the growth rate of Gdp and in the other case an interest rate;
- and an corporeality of time over which this effect happens.
Recall that compound interest is involvement that is earned on by involvement. It causes the full corporeality of financial savings to abound dramatically over time. Similarly, compound rates of economic growth, or the compound growth rate, ways that the rate of growth is existence multiplied by a base that includes by GDP growth, with dramatic furnishings over fourth dimension.
For example, in 2013, the World Fact Book, produced by the Central Intelligence Agency, reported that Republic of korea had a GDP of $1.67 trillion with a growth rate of 2.8%. We tin can estimate that at that growth rate, South Korea's Gdp will be $1.92 trillion in v years. If we utilize the growth rate to each year's ending Gdp for the adjacent five years, nosotros will calculate that at the end of year 1, GDP is $1.72 trillion. In year ii, we start with the stop-of-year one value of $1.67 and increase it by 2%. Twelvemonth three starts with the end-of-year two Gdp, and we increase it by two% so on, every bit depicted in the Table 4.
| Year | Starting GDP | Growth Rate two% | Year-End Amount |
|---|---|---|---|
| 1 | $1.67 Trillion × | (1+0.028) | $1.72 Trillion |
| 2 | $ane.72 Trillion × | (1+0.028) | $i.76 Trillion |
| 3 | $1.76 Trillion × | (1+0.028) | $1.81 Trillion |
| iv | $1.81 Trillion × | (1+0.028) | $ane.87 Trillion |
| 5 | $1.87 Trillion × | (1+0.028) | $one.92 Trillion |
| Table 4. | |||
Another fashion to calculate the growth rate is to apply the following formula:
[latex]Time to come\;Value = Present\;Value\;\times\;(1\;+\;g)^n[/latex]
Where "future value" is the value of GDP five years hence, "present value" is the starting Gross domestic product amount of $1.64 trillion, "g" is the growth rate of two%, and "n" is the number of periods for which nosotros are computing growth.
[latex]Future\;Value = 1.67\;\times\;(1\;+\;0.028)^5 = \$i.92\;trillion[/latex]
Central Concepts and Summary
Productivity, the value of what is produced per worker, or per 60 minutes worked, tin be measured equally the level of GDP per worker or GDP per hour. The Usa experienced a productivity slowdown between 1973 and 1989. Since then, U.Southward. productivity has rebounded (the current global recession however). Information technology is not clear whether the electric current growth in productivity will be sustained. The rate of productivity growth is the main determinant of an economy'south charge per unit of long-term economic growth and higher wages. Over decades and generations, seemingly pocket-sized differences of a few pct points in the annual rate of economic growth make an enormous departure in GDP per capita. An amass production office specifies how certain inputs in the economy, like man upper-case letter, physical capital, and engineering, lead to the output measured as GDP per capita.
Compound interest and compound growth rates behave in the same way as productivity rates. Seemingly small changes in percentage points can accept big impacts on income over time.
Cocky-Cheque Questions
- Are there other ways in which we can measure out productivity besides the amount produced per hour of work?
- Assume at that place are two countries: South Korea and the United States. Southward Korea grows at 4% and the United States grows at 1%. For the sake of simplicity, assume they both start from the same fictional income level, $10,000. What will the incomes of the United States and South korea be in 20 years? Past how many multiples will each country'south income grow in 20 years?
Review Questions
- How is Gdp per capita calculated differently from labor productivity?
- How do gains in labor productivity lead to gains in Gross domestic product per capita?
Critical Thinking Questions
- Labor Productivity and Economic Growth outlined the logic of how increased productivity is associated with increased wages. Detail a situation where this is not the example and explain why information technology is not.
- Modify in labor productivity is one of the most watched international statistics of growth. Visit the St. Louis Federal Reserve website and find the data section (http://enquiry.stlouisfed.org). Find international comparisons of labor productivity, listed nether the FRED Economical database (Growth Rate of Full Labor Productivity), and compare two countries in the recent by. Country what you call back the reasons for differences in labor productivity could exist.
- Refer back to the Piece of work It Out almost Comparison the Economies of Ii Countries and examine the data for the two countries you chose. How are they like? How are they different?
Problems
- An economy starts off with a GDP per capita of $5,000. How large will the GDP per capita exist if information technology grows at an annual rate of 2% for 20 years? two% for 40 years? 4% for 40 years? 6% for forty years?
- An economy starts off with a GDP per capita of 12,000 euros. How large will the Gdp per capita be if it grows at an annual rate of three% for 10 years? iii% for xxx years? 6% for 30 years?
- Say that the average worker in Canada has a productivity level of $30 per 60 minutes while the boilerplate worker in the United Kingdom has a productivity level of $25 per hour (both measured in U.S. dollars). Over the next five years, say that worker productivity in Canada grows at ane% per twelvemonth while worker productivity in the United kingdom of great britain and northern ireland grows iii% per year. Afterwards five years, who will have the college productivity level, and by how much?
- Say that the average worker in the U.S. economy is eight times as productive as an average worker in Mexico. If the productivity of U.Due south. workers grows at two% for 25 years and the productivity of United mexican states'south workers grows at six% for 25 years, which country volition have higher worker productivity at that point?
Glossary
- amass production function
- the process whereby an economy as a whole turns economical inputs such every bit human capital, physical capital letter, and technology into output measured as Gross domestic product per capita
- chemical compound growth rate
- the rate of growth when multiplied by a base that includes by Gross domestic product growth
- human capital
- the accumulated skills and education of workers
- innovation
- putting advances in knowledge to use in a new production or service
- invention
- advances in noesis
- labor productivity
- the value of what is produced per worker, or per hour worked (sometimes chosen worker productivity)
- production function
- the procedure whereby a house turns economic inputs like labor, machinery, and raw materials into outputs like goods and services used past consumers
- technological alter
- a combination of invention—advances in noesis—and innovation
Solutions
Answers to Self-Cheque Questions
- Yes. Since productivity is output per unit of input, we can measure productivity using GDP (output) per worker (input).
- In 20 years the United States will take an income of 10,000 × (ane + 0.01)20 = $12,201.90, and South Korea will have an income of x,000 × (one + 0.04)xx = $21,911.23. South korea has grown by a multiple of 2.1 and the United States by a multiple of 1.two.
Source: https://opentextbc.ca/principlesofeconomics/chapter/20-2-labor-productivity-and-economic-growth/
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