The factors of Economic Growth

Economic growth depends on the use of the factors of production. These factors of production are capital, labor and total factor productivity. The labor factor refers to the quantity of labor used, it is therefore linked to the active population, as well as to the duration of the work, but also to the quality of the work, to the know-how accumulated by the worker, what called human capital. The capital factor refers to investment, ie the increase in the stock of capital. Finally, total factor productivity (TFP) refers to everything that is not explained by the two classic factors of production: it is organizational innovation (Taylorism for example) or even technological innovation.

1/ Labor and capital are the two main factors of production that will enable economic growth. 

A/ Depending on the use made of the factors of production, economic growth can be:

  • extensive: it relies solely on the growth of capital and labor (for example: an influx of migrants or the discovery of new natural resources);
  • intensive: it designates a more efficient use of the factors of production, it is then based on productivity gains and economies of scale (for example: the industrialization of a geographical area).

B/ Economic growth will be stimulated by increased use of the labor factor .
a/ Several possibilities exist to promote the extensive growth of the labor factor.
(1) The labor factor can first be stimulated by an increase in the active population , ie the population in the labor market. In the short term, an increase in the number of immigrants can make it possible to increase this active population. In the longer term, it is the birth rate that is observed as an element to be taken into account for the future dynamics of growth.

This labor force can also be increased in the short term by increasing the employment rate. The employment rate is the ratio between the number of individuals in a category of the population and the number of this category who have a job. For example, the European Union’s Europe 2020 strategy aims to raise the employment rate of the population aged 20-64 to 75% . For this, it is necessary to act on certain categories of the population whose employment rate is low, in particular that of young people.
(2) The labor factor can then be stimulated by an increase in the duration of working time. However, we note that the long-term trend is rather towards a reduction in working time. In France, the annual duration of working time was halved from 1900 to the 2000s (the number of hours worked fell from 3000 to 1461 hours per year between 1896 and 2004). In recent years, the shift to 35 hours and the development of part-time work have further contributed to this decrease.

b/ Over the long term, it can be seen that the reduction in working hours has offset the increase in the active population. The real growth of the labor factor has therefore taken place through the intensive growth , that is to say by productivity gains and economies of scale more than by increasing the quantity of work. Hourly labor productivity was multiplied by 16 between 1896 and 1996. This growth is explained by an improvement in the organization of work, but also by an increase in the stock of human capital.
Human capital refers to all the skills that can be valued economically. This notion was introduced by Théodore Schultz who, in “Investment in human capital” (1961), argues that knowledge and skills are a form of capital and that this capital is the product of “voluntary investment”. He then shows that there is a link between the growth of Western countries and investment in human capital, particularly in education.

A few years later, Gary Becker in Human Capital, A Theoretical and Empirical Analysis (1964), took up the concept of “human capital” from Schultz and defined it as a stock of productive resources incorporated into individuals themselves, made up of elements as diverse as level of education, training and professional experience, state of health or knowledge of the economic system. In other words, any form of activity likely to affect this stock (continuing one’s studies, taking care of oneself, etc.) is defined as an investment in human capital.

Consequently, from the point of view of these economists, raising the level of education constitutes a sustainable source of growth that is all the more interesting since the increase in the stock of human capital is a cumulative process: when basic knowledge is assimilated , it is then easier to acquire new knowledge.

C/ The increase in the stock of capital , that is to say investment, makes it possible to ensure sustainable growth. Like labor, capital can grow extensively or intensively .
a/ In the case of extensive growth , the increase in capital can result in the purchase of new machinery, which has the effect of modernizing the existing stock of capital, or else in the purchase of more raw materials (intermediate consumption).

b/ In the case of intensive growth, it is a substitution of capital for labor. More efficient machines make it possible to replace the work carried out by man, which leads to an increase in capital intensity , that is to say in the volume of capital per worker.

2/ Whether through the increase in the labor factor or the capital factor, the overall productivity of factors is a key factor in intensive growth. 

A/ Total factor productivity (TFP) refers to the ratio between production and the total volume of factors used. In other words, TFP measures the increase in wealth that is not explained by the increase in factors of production. It therefore acts as a third factor.
The most central element in TFP is certainly technical progress. Technical progress can designate both a qualitative improvement of the factors of production, due to technical innovations, or even their use, due to organizational innovations such as Taylorism for example.

B/ Economic theory owes Robert Solow to have measured the contribution of technical progress to growth. In “ A Contribution to the Theory of Economic Growth ” (1957), he notes the existence of a residual, that is to say of an unexplained part of growth, once the growth linked to increase in factors of production has been taken into account.
However, this taking into account of technical progress is done exogenously, it amounts to analyzing it like a “manna fallen from the sky”  in Solow’s terms. Technical progress is considered autonomous: a significant part of growth comes from technical progress, but it is not clear why.

In “ Increasing Returns and Long Run Growth” (1986), Paul Romer develops a theory of growth which is, this time, endogenous . Its purpose is to explain economic growth based on microeconomic processes and decisions. According to Romer, growth is based on investments in R&D. R&D enables discoveries that benefit all economic agents due to the positive externalities it generates.
Other authors, within a framework of micro-economic analysis, insist on other endogenous variables of technical progress:

  • Robert Lucas  (“ On the mechanics of economic development ”, 1988) highlights the accumulation of human capital ;
  • Robert Barro (“ Party politics of growth ”, 1994) underlines the positive role of public investments when these nevertheless remain within balanced budgets (according to Barro, the State is ineffective in influencing the economic situation by means of the public deficit, but its action can generate positive externalities provided that they compensate for the negative impact of compulsory levies on economic activity, in particular by helping fundamental research and by adopting an approach favorable to the existence of monopolies in high-growth sectors ).
  • This neo-classical approach, known as endogenous growth models, paradoxically favors a return of the state, particularly in key sectors for growth. For example, the Europe 2020 strategy has set itself the objective of bringing the ratio of R&D expenditure to GDP to 3% (compared to approximately 2% currently). In this, it takes up the objective of the Lisbon Strategy (for 2010) to make Europe “the most competitive knowledge-based economy in the world” (cf. The five main objectives of Europe 2020 ).

C/ In the 20th century, technical progress played a fundamental role in economic growth. In French growth (1972), Carré, Dubois and Malinvaud use Solow’s methodology to show that, during the period of the Glorious Thirties, half of total growth was due to technical progress . However, the PGF will decrease at the end of this period.

In the 1980s, the development of information technology did not lead, contrary to what one might have expected, to an increase in TFP. We still owe this observation to Robert Solow in “We’d better watch out” (1987). Solow’s paradox is stated as follows:computers are everywhere, except in productivity statistics” . This paradox is explained by the slowness with which a new technology produces macro-economic effects, in particular because it induces a strong investment in time to learn how to use it in an optimal way and because it also requires a reorganization in depth of companies or administrations.

In “The paradox of productivity: organizational changes, a complementary factor to computerization” (2000), Philippe Askenazy returns to this last point and considers that the apparent lack of impact of information technologies on the overall productivity of factors in the United States actually hides a double phenomenon:

  • strong productivity gains in companies that have simultaneously adopted technological and organizational innovations;
  • a failure of computerization in companies that have not reorganized their production process.
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D/ The importance of technical progress and innovation in growth has led the public authorities to become aware of the effort to be made in this area. The research tax credit in France is an example: introduced in 2008, it consists of a tax credit of 30% of R&D expenditure up to 100,000 euros and 5% beyond this amount.

But the most visible manifestation of this concern is still the share of R&D expenditure in relation to GDP. Some states, such as Finland, have thus clearly opted for a growth model based on innovation: their R&D expenditure amounts to nearly 4% of GDP. The Europe 2020 strategy also seeks to find growth drivers in this area, although its objective of increasing R&D expenditure to 3% is still quite distant, the European Union of 27 being closer to 2%. It is still far from its main economic rival, the United States, which is approaching 3%.

The graph below shows the differences between the main developed countries in terms of R&D. They can be a means of explaining the growth differential that exists between these different countries, in particular between European growth and American growth. Note that all the countries below, with the notable exception of Japan, are increasing their R&D spending.

SAKHRI Mohamed
SAKHRI Mohamed

I hold a Bachelor's degree in Political Science and International Relations in addition to a Master's degree in International Security Studies. Alongside this, I have a passion for web development. During my studies, I acquired a strong understanding of fundamental political concepts and theories in international relations, security studies, and strategic studies.

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