Over the past two centuries the industrialized nations saw enormous improvements in living standards, as reflected in large increases in real GDP per person. Because of the power of compound interest, relatively small differences in growth rates, if continued over long periods, can produce large differences in real GDP per person and average living standards. Thus, the rate of long-term economic growth is an economic variable of critical importance.
Real GDP per person is the product of average labor productivity (real GDP per employed worker) and the share of the population that is employed. Growth in real GDP per person can occur only through growth in average labor productivity, in the share of the population that is working, or both. In the period since 1960, increases in the share of the U.S. population holding a job contributed significantly to rising real GDP per person. But in the past four decades, as in most periods, the main source of the increase in real GDP per person was rising average labor productivity.
Among the factors that determine labor productivity are the talents, education, training, and skills of workers, or human capital; the quantity and quality of the physical capital that workers use; the availability of land and other natural resources; the application of technology to the production and distribution of goods and services; the effectiveness of entrepreneurs and managers; and the broad social and legal environment. Because of diminishing returns to capital, beyond a certain point expansion of the capital stock is not the most effective way to increase average labor productivity. Economists generally agree that new technologies are the most important single source of improvements in productivity.
Since the 1970s the industrial world has experienced a slowdown in productivity growth. Some economists have suggested that the "slowdown" is more the result of an inability to measure increases in the quality of output than of any real economic change. Others have suggested that the exploitation of a backlog of technological opportunities following the Great Depression and World War II led to unusually high growth rates in the 1950s and 1960s, a view called the technological depletion hypothesis. In this view, the slower growth in U.S. productivity since about 1970 in fact reflects a return to a more normal rate of growth. U.S. productivity growth has picked up since about 1991, however, possibly as the result of new technologies.
Economic growth has costs as well as benefits. Prominent among them is the need to sacrifice current consumption to achieve a high rate of investment in new capital goods; other costs of growing more quickly include extra work effort and the costs of research and development. Thus more economic growth is not necessarily better; whether increased economic growth is desirable depends on whether the benefits of growth outweigh the costs.
Among the ways in which government can stimulate economic growth are by adopting policies that encourage the creation of human capital; that promote saving and investment, including public investment in infrastructure; that support research and development, particularly in the basic sciences; and that provide a legal and political framework that supports private-sector activities. The poorest countries, with poorly developed legal, tax, and regulatory systems, are often in the greatest need of an improved legal and political framework and increased political stability.
Are there limits to growth? Arguments that economic growth must be constrained by environmental problems and the limits of natural resources ignore the fact that economic growth can take the form of increasing quality as well as increasing quantity. Indeed, increases in output can provide additional resources for cleaning up the environment. Finally, the market system, together with political processes, can solve many of the problems associated with economic growth. On the other hand, global environmental problems, which can be handled neither by the market nor by individual national governments, have the potential to constrain economic growth.
