Chapter 18 - Economic growth

Why nations become rich: the crucial role of average labor productivity

• Average labor productivity: output per employed worker.

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• Real GDP per person, a basic indicator of living standards, has grown dramatically in the industrialized countries. This growth reflects the power of compound interest: Even a modest growth rate, if sustained over a long period of time, can lead to large increases in the size of the economy.

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• Output per person equals average labor productivity times the share of the population that is employed. Since 1960 the share of the U.S. population with jobs has risen significantly, but this variable has started to decline in recent years. In the long run, increases in output per person and hence living standards arise primarily from increases in average labor productivity.

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Determinants of average labor productivity

• Human capital: amalgam of factors such as education, training, experience, intelligence, energy, work habits, trustworthiness, and initiative that affects the value of a worker's marginal product.

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• Diminishing returns to capital: if the amount of labor and other inputs employed is held constant, then the greater the amount of capital already in use, the less an additional unit of capital adds to production.

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• Key factors determining average labor productivity in a country include:
  • Skills and training of workers, called human capital
  • Quantity and quality of physical capital machines, equipment, and buildings
  • Availability of land and other natural resources
  • Sophistication of the technologies applied in production
  • Effectiveness of management and entrepreneurship
  • Broad social and legal environment

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