A Strategy for Economic Growth
1. The Key to Economic Growth is Rising Productivity
Sustained economic growth means ongoing increases in per capita income and output.4 In most cases, the increases achieved seem small from one year to the next. But compounded over a generation, they can produce dramatic improvements in the well-being of ordinary people.
The United States never achieved the sustained high growth rates of a South Korea. It became rich by growing at more modest rates for more than two centuries. Estimates of the average growth in per capita U.S. output since independence range from 1.7 percent to 2.2 percent per year. This suggests 2 percent per year as a benchmark of minimally acceptable per capita growth. If a poor country grows at this rate, it is doing as well as the United States has done over the long term. If it does so consistently, it will eventually achieve affluence. If it grows faster – and many have – its living standards will gradually gain on those of the United States and other rich countries.
Economic growth occurs as societies accumulate and equip workers with more and better physical capital (e.g., factories and infrastructure) and human capital (skills and knowledge), and use these assets ever more productively to produce goods and services of increasing value. Among these sources of growth, increases in productivity account for most of the differences in economic growth among countries. 5 Productivity grows as producers – entrepreneurs operating at all scales – find ways to squeeze more output from a given set of inputs. They do so by adopting more efficient production methods, applying technical knowledge to create better products, changing their product mix, etc. Capital accumulation and productivity growth both result from the independent efforts of millions of individual producers, constantly working to create new, better, and less costly goods and services through ingenuity and investment. Those efforts, in turn, are guided by the incentives that producers face – incentives strongly affected by public policies and regulations, macroeconomic stability, the enforcement of contracts and property rights, the prevalence or absence of corruption, and other aspects of economic governance.
4 In a market system, income and output are closely related, both conceptually and as measured statistically. This strategy uses these terms interchangeably. p>
5 According to the most painstaking estimates, differences in productivity growth account for 90 percent of the differences among countries in the growth rate of output per worker. Klenow and Rodriguez-Clare (1997).
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