Economic growth is the increase in the inflation-adjusted market value of the goods and services produced by an economy over time. It is conventionally measured as the percent rate of increase in real gross domestic product, or real GDP, usually in per capita terms.
Growth is usually calculated in real terms – i.e., inflation-adjusted terms – to eliminate the distorting effect of inflation on the price of goods produced. Measurement of economic growth uses national income accounting. Since economic growth is measured as the annual percent change of gross domestic product (GDP), it has all the advantages and drawbacks of that measure.
The “rate of economic growth” refers to the geometric annual rate of growth in GDP between the first and the last year over a period of time. Implicitly, this growth rate is the trend in the average level of GDP over the period, which implicitly ignores the fluctuations in the GDP around this trend.
An increase in economic growth caused by more efficient use of inputs (such as labor productivity, physical capital, energy or materials) is referred to as intensive growth. GDP growth caused only by increases in the amount of inputs available for use (increased population, new territory) is called extensive growth.
Productivity and Growth
Productivity describes various measures of the efficiency of production. A productivity measure is expressed as the ratio of output to inputs used in a production process, i.e. output per unit of input. Productivity is a crucial factor in production performance of firms and nations. Increasing national productivity can raise living standards because more real income improves people’s ability to purchase goods and services, enjoy leisure, improve housing and education and contribute to social and environmental programs. Productivity growth also helps businesses to be more profitable. There are many different definitions of productivity and the choice among them depends on the purpose of the productivity measurement and/or data availability.
Productivity measures that use one class of inputs or factors, but not multiple factors, are called partial productivities. In practice, measurement in production means measures of partial productivity. Interpreted correctly, these components are indicative of productivity development, and approximate the efficiency with which inputs are used in an economy to produce goods and services. However, productivity is only measured partially – or approximately. In a way, the measurements are defective because they do not measure everything, but it is possible to interpret correctly the results of partial productivity and to benefit from them in practical situations. At the company level, typical partial productivity measures are such things as worker hours, materials or energy used per unit of production.
Before widespread use of computer networks, partial productivity was tracked in tabular form and with hand-drawn graphs. Tabulating machines for data processing began being widely used in the 1920s and 1930s and remained in use until mainframe computers became widespread in the late 1960s through the 1970s. By the late 1970s inexpensive computers allowed industrial operations to perform process control and track productivity. Today data collection is largely computerized and almost any variable can be viewed graphically in real time or retrieved for selected time periods.
Labor productivity is a measure of economic growth within a country. Labor productivity measures the amount of goods and services produced by one hour of labor; specifically, labor productivity measures the amount of real gross domestic product (GDP) produced by an hour of labor. Growth in labor productivity depends on three main factors: investment and saving in physical capital, new technology, and human capital.
BREAKING DOWN ‘Labor Productivity’
Labor productivity is defined as real economic output per labor hour. Growth in labor productivity is measured by the change in economic output per labor hour over a defined period of time.
For example, suppose the real GDP of an economy is $10 trillion and the aggregate hours of labor in the country is 300 billion. The labor productivity would be $10 trillion divided by 300 billion, equaling about $33 per labor hour. If the real GDP of the same economy grows to $20 trillion the next year and its labor hours increases to 350 billion, the economy’s growth in labor productivity would be 72%.
The growth number is derived by dividing the new real GDP of $57 by the previous real GDP of $33. Growth in this labor productivity number can usually be interpreted as improved standards of living in the country.
The Importance of Measuring Labor Productivity
Labor productivity is directly linked to improved standards of living in the form of higher consumption. As an economy’s labor productivity grows, it produces more goods and services for the same amount of relative work. This increase in output makes it possible to consume more of the goods and services for an increasingly reasonable price.
Growth in labor productivity is directly attributable to fluctuations in physical capital, new technology and human capital. If labor productivity is growing, it can be traced back to growth in one of these three areas. Physical capital is the amount of money that people have in savings and investments. New technologies are technological advancements, such as robots or assembly lines. Human capital represents the increase in education and specialization of the workforce. Measuring labor productivity allows an economy to understand these underlying trends.
Labor productivity is also an important measure of the short-term and cyclical changes in an economy. High-level labor productivity is a combination of total output and labor hours. Measuring labor productivity each quarter allows an economy to measure the change in its output in relation to the change in its labor hours.
If output is increasing while labor hours remains static, it could be a sign that the economy is advancing technologically and should continue to do so. Conversely, if labor hours increases in relation to flat output, it may be a sign that the economy needs to invest in education to increase its human capital.