Economic Growth and Productivity
This domain focuses on long-run increases in potential output: sources of productivity growth, capital deepening, human capital, technology, institutions, and policies that raise the growth rate. CLEP questions distinguish increases in the level of GDP from increases in the growth rate and apply the rule of 70.
Sources of growth
- Growth accounting: output growth = capital's share × capital growth + labor's share × labor growth + total factor productivity growth.
- Productivity is output per worker or per hour; it rises with capital per worker, human capital, technology, and efficiency.
- Diminishing returns to capital imply that extra capital raises output by less and less; low-income countries may experience catch-up convergence.
Growth-friendly policies
- Raise saving and investment, improve education and training, support research and development, and build infrastructure.
- Protect property rights, enforce contracts, maintain the rule of law, keep inflation stable, and remain open to trade.
- Rule of 70: doubling time ≈ 70 / annual growth rate in percent.
- Long-run growth is supply-side; demand stimulus does not shift LRAS.
Worked example
At 2% annual growth, real GDP doubles in about 70 / 2 = 35 years. At 7%, it doubles in about 10 years. Now suppose real GDP is $2,000 billion with 100 million workers, so output per worker is $20,000. If output rises to $2,200 billion and workers to 110 million, output per worker is still $20,000: GDP grew, but productivity did not. Living standards depend on output per person, not just total output.
Traps that cost marks
- A higher GDP level is not the same as a higher growth rate.
- Population growth can raise total GDP while leaving GDP per capita unchanged.
- Diminishing returns mean capital accumulation alone cannot sustain growth indefinitely.
- Institutions and technology matter more for long-run growth than short-run demand management.
- Do not confuse an outward shift of LRAS with a movement along SRAS.