15.1 Determinants of Economic Growth

Economic growth is driven by productivity gains, technological progress, and human capital development. These factors interact with institutional frameworks, resource availability, and international trade to shape long-term economic performance.

Understanding the determinants of growth is crucial for policymakers and businesses. By focusing on education, innovation, and sound institutions, countries can create environments conducive to sustained economic expansion and improved living standards.

Drivers of Long-Term Growth

Productivity and Technological Progress

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• Long-term economic growth driven by increases in productivity measured as output per unit of input (labor or capital)
• Technological progress enables more efficient production methods and creates new products and industries
• Capital accumulation (physical and human) increases productive capacity and workforce skills
• Population growth and demographic changes impact economic growth through labor force size and composition changes

Resource Factors and Institutional Environment

• Natural resources not necessarily determinant of long-term growth (resource-poor countries have achieved high growth rates)
• Institutions and policies create environment conducive to economic growth
  • Property rights
  • Rule of law
  • Market-friendly regulations
• International trade and economic integration contribute to growth
  • Expand markets
  • Facilitate technology transfer
  • Promote competition

Human Capital for Growth

Education and Productivity

• Human capital encompasses knowledge, skills, and abilities possessed by individuals enhanced through education, training, and experience
• Education increases labor productivity by improving workers' skills, knowledge, and ability to adapt to new technologies and processes
• Higher levels of human capital foster innovation and technological progress
• Quality of education crucial for economic growth
  • Emphasis on critical thinking, problem-solving, and adaptability
• Investment in human capital leads to positive externalities
  • Improved health outcomes
  • Lower crime rates

Economic Impact of Human Capital

• Relationship between human capital and economic growth characterized by increasing returns to scale
  • Benefits of education multiply as overall level of human capital in economy rises
• Human capital development helps reduce income inequality and promote social mobility
  • Leads to more stable and sustainable economic growth

Institutions and Economic Growth

Legal and Political Foundations

• Institutions shape economic behavior and interactions in society through formal and informal rules, norms, and constraints
• Strong property rights and contract enforcement encourage investment and entrepreneurship
  • Reduce uncertainty and transaction costs
• Rule of law and independent judiciary create stable business environment
  • Attract domestic and foreign investment
• Political stability essential for long-term economic planning and sustained growth
  • Absence of violence or terrorism

Governance and Regulatory Environment

• Effective governance enhances efficiency of public services and resource allocation
  • Control of corruption
  • Government effectiveness
• Regulatory quality affects ease of doing business and market efficiency
  • Ability to formulate and implement sound policies
• Complex relationship between democracy and economic growth
  • Democratic institutions promote growth through accountability and protection of individual rights
  • Authoritarian regimes sometimes implement growth-promoting policies more effectively

Savings and Investment Significance

Domestic Savings and Investment

• Savings provide financial resources for investment in physical capital
  • Expand productive capacity
  • Adopt new technologies
• Savings rate influenced by income levels, demographic structure, and cultural attitudes
• Investment in productive assets increases capital stock and enhances labor productivity
  • Machinery
  • Infrastructure
  • Technology
• Efficiency of investment measured by incremental capital-output ratio (ICOR)

International Investment and Financial Systems

• Foreign direct investment (FDI) supplements domestic savings
  • Brings technology transfer and managerial expertise
• Financial intermediation channels savings into productive investments
  • Highlights importance of well-developed financial system for economic growth
• Balance between savings and consumption crucial
  • Excessive savings can lead to deficient aggregate demand
  • Insufficient savings can constrain investment and future growth potential