[MUSIC] Labor inputs include, of course the quantity of workers. However, many economists believe that the quality of labor inputs, the skills, knowledge, and discipline of the labor force, is the single most important element in economic growth. A country might buy the most modern telecommunications devices, computers, electricity generating equipment, and fighter aircraft. However, these capital goods can be effectively used and maintained only by skilled and trained workers. Improvements in literacy, health, and discipline, and most recently, the ability to use computers, add greatly to the productivity of labor. The second supply factor or production is natural resources. The important resources here are, arable land, oil and gas, forests, water, and mineral resources. Some high income countries like Canada and Norway, have grown primarily on the basis of their ample resource base. With large outputs in agriculture, fisheries, and forestry. Similarly, the United States with its temperate farmlands is the world's largest producer and exporter of grains. But the possession of natural resources is hardly necessary for economic success in the modern world. New York City prospers primarily on its high density service industries. While many countries that have virtually no natural resources, such as Japan, have thrived by concentrating on sectors that depend more on labor and capital than on indigenous resources. The third supply factor of growth is capital formation. Tangible capital includes structures like roads, and power plants, and equipment, like trucks and computers. In this regard, some of the most dramatic stories in economic history, often involve the rapid accumulation of capital. For example, in the 19th century, the transcontinental railroads of North America brought commerce to the American heartland, which had been living in isolation. While in the 20th century, successive waves of investment in automobiles, roads, and power plants, increase productivity, and provided the infrastructure which created entire new industries. Note, however, that accumulating capital requires a sacrifice of current consumption over many years. Countries that grow rapidly, tend to invest heavily in new capital goods. In the most rapidly growing countries, 10 to 20% of output may go into capital formation. In this regard when we think of capital we must not concentrate only on private sector investment. In fact, many investments are undertaken only be governments, and provide the necessary social overhead capital and infrastructure for businesses to prosper. Roads, irrigation and water projects, and public health measures are important. All these involve large investments, that tend to be indivisible, or lumpy, and sometimes have increasing returns to scale. These projects generally involve external economies or spill-overs, that private firms cannot capture. So the government must step in, to ensure that they are effectively undertaken. In addition to the three supply factors discussed above, technological advance has been a vital fourth ingredient in the rapid growth of living standards. Historically, growth has definitely not been a process of simple replication, adding rows of steel mills, or power plants next to each other. Rather, a never-ending stream of inventions and technological advances led to a vast improvement in the production possibilites of Europe, North America, and Japan. Technological change denotes changes in production processes or the introduction of new products or services. Process inventions that have greatly increased productivity were the steam engine, the generation of electricity, the internal combustion engine, the wide bodied jet, the photocopier machine, and the fax machine. Fundamental product inventions include the telephone, the radio, the airplane, the phonograph, the television, and the VCR. Today the most dramatic technological developments are occurring in electronics and computers. Where tiny notebook computers can now out perform the fastest computer of the 1960s. These inventions provide the most spectacular examples of technological change. But technological change is a continuous process of small and large improvements. This is witnessed by the fact that the United States issues over 100,000 new patents annually. And there are millions of other small refinements that are part of the routine progress of an economy. While the four supply factors of growth relate to the physical ability of the economy to expand, there are two other factors that are equally important. First, there is the demand factor. To realize its growing production potential, a nation must fully employ its expanding supply of resources. This requires a growing level of aggregate demand. Second, there is the efficiency factor. To reach its production potential, a nation must not only achieve full employment, but also two kinds of economic efficiency. Specifically, a country must achieve productive efficiency. That is, it must use its existing and new resources in the least costly way to produce what it does. And it must also achieve allocative efficiency, meaning that the specific mix of goods and services it produces must maximize society's well-being. An idea developed more fully in microeconomics. Now, we can illustrate how the six factors of economic growth interact using the following production possibilities curve. Here we see that a country starts at point A. Then growth is made possible by the four supply factors which shift the production possibilities curve outward. As from A-B to C-D. But economic growth is realized only when the demand and efficiency factors move the economy from point A to point B. This table summarizes the results of one of the most famous studies ever conducted in economics. The study was done by Edward Denisen. He estimated what percentage of annual U.S. growth between 1929 and 1982 was accounted for by each factor listed in the table. Here, we see quite clearly that productivity growth has been the most important force underlying the growth of U.S. real output and income. In particular, while item one shows that 1 3rd of the increase in real output occurred because of increases in the quantity of labor, item 2 indicates that the remaining 2 3rds was due to increases in labor productivity. Now here is where this table really gets interesting, because it helps answer this question. Which factors of growth have been most instrumental in increasing labor productivity? Clearly, the quantity of capital, more education and training, economies of scale and production, and improved resource allocation, have all been important. However, the most important factor, accounting for a full 28% of increased productivity, has been technological advance. Just as our growth theory suggested. And by the way, you should note that the eighth category is a negative number. It estimates the negative impact that legal and regulatory constraints have had on productivity and growth.
