No Such Thing as a Free Lunch: Principles of Economics (Part 162)

We've seen over time that countries that have the best economic growth are those that have good governance, and good governance comes from freedom of communication. It comes from ending corruption. It comes from a populace that can go online and say, 'This politician is corrupt, this administrator, or this public official is corrupt.'

Ramez Naam

Long-Run Growth

(Part C)

by

Charles Lamson

Increases in Physical Capital

An increase in the stock of capital can also increase output, even if it is not accompanied by an increase in the labor force. Physical capital both enhances the productivity of labor and provides valuable services directly.

It is easy to see how capital provides services directly. Consider what happened on the deserted island that Bill and Colleen washed up on in the last post. In the first few years, they built their house, putting many hours of work into it that could have gone into producing other things for immediate consumption. With the house for shelter, Colleen and Bill can spend time on other things. In the same way, capital equipment produced in one year can add to the value of a product over many years. For example, we still derive use and value from bridges and tunnels built decades ago.

It is also easy to see how capital used in production enhances the productivity of labor. Computers enable us to do almost instantly tasks that once were impossible or might have taken years to complete. An airplane with a small crew can transport hundreds of people thousands of miles in a few hours. A bridge over a river at a critical location may save thousands of labor hours that would be spent transporting materials and people the long way around. It is precisely this yield in the form of future valuable services that provides both private and public investors with the incentive to devote resources to capital production.

Table 3 shows how an increase in capital without a corresponding increase in labor might increase output. Observe several things about these numbers. First, additional capital increases measured productivity; output per worker (Y/L) increases from 3.0 to 3.1, to 3.2, and finally to 3.3 as the quantity of capital (K) increases. Second, there are diminishing returns to capital. Increase in capital by 10 units first increases output by 10 units from 300 in period 1 to 310 in period 2. However, the second increase of 10 units yields only 9 units of output, and the third increase yields only eight units.

In all economies experiencing modern economic growth, capital expands at a more rapid rate than labor. That is, the ratio of capital to labor (K/L) increases, and this too is a source of increasing productivity.

Increases in Human Capital

Investment in human capital is another source of economic growth. People in good health are more productive than people in poor health; people with skills are more productive than people without them.

Human capital can be produced in many ways. Individuals can invest in themselves by going to college or vocational training programs. Firms can invest in human capital through on-the-job training. The government invests in human capital with programs to improve health and to provide schooling and job training.

*CASE & FAIR, 2004, PRINCIPALS OF ECONOMICS, 7TH ED., PP. 634-636* 

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