Sources of Economic Growth

Sources of Economic Growth

One way for an economy to produce more output is to obtain more resources. Even with the same resources, however, it is possible for an economy to produce more output if workers become more productive. Productivity is the quantity of goods and services produced from a typical hour of a worker’s labor. Improvements in productivity allow an economy to produce more output and thus earn more income. This increased income represents an improved standard of living. Thus an increased standard of living usually depends on increasing a country’s productivity. Thus, improved productivity is the key to economic growth.

Increases in productivity fall into three categories:

1. Investment in physical capital – “Build more machines.”
2. Investment in human capital (education and skills) – “Make workers more productive.”
3. Investment in technology – “Build more productive machines.”


Investment in physical capital

Physical capital is anything man-made that makes labor more productive. Fiscal policies to increase investment in physical capital include direct government spending on infrastructure (e.g., roads, bridges, hospitals) and tax incentives to encourage private businesses to invest (e.g., new factories or machinery). Monetary policies that achieve low interest rates also encourage businesses to invest more in physical capital by decreasing its opportunity cost.


Investment in human capital

Human capital is the education, training, and skills people acquire that makes them more productive. Fiscal policies to increase investment in human capital include direct government spending on education and job training or tax incentives to encourage education and skills training. Monetary polices that keep interest rates low may also make it easier for people to acquire more education by lowering the cost of loans to pay tuition and other expenses.


Investment in technology

Technological innovations usually create increases in productivity. For example, scientists have developed agricultural crops that are more disease-resistant and have thus increased the yields from our farmland. Fiscal policies that promote investment in technology include direct government spending on research and development [e.g., National Science Foundation (NSF) grants] and tax incentives to encourage private businesses to invest in discovering new technologies. Monetary policies that keep interest rates low also encourage businesses to invest in technology by decreasing the cost of borrowing money.

Economic Growth - Topics