Chapter 12

What's the important distinguishment between human capital and technological knowledge?

It is worthwhile to distinguish between technological knowledge and human capital. Although they are closely related, there is an important difference. Technological knowledge refers to society's understanding about how the world works. Human capital refers to the resources expended transmitting this understanding to the labor force. To use a relevant metaphor, technological knowledge is the quality of society's textbooks, whereas human capital is the amount of time that the population has devoted to reading them. Workers' productivity depends on both.

What property does the production function have?

Many production functions have a property called constant returns to scale. If a production function has constant returns to scale, then doubling all inputs causes the amount of output to double as well.

How many forms does technological knowledge take?

- Some technology is common knowledge—after one person uses it, everyone becomes aware of it. - Other technology is proprietary—it is known only by the company that discovers it. Only the Coca-Cola Company, for instance, knows the secret recipe for making its famous soft drink. Still other technology is proprietary for a short time. When a pharmaceutical company discovers a new drug, the patent system gives that company a temporary right to be its exclusive manufacturer. When the patent expires, however, other companies are allowed to make the drug. All these forms of technological knowledge are important for the economy's production of goods and services.

Which two forms do natural resources take?

- renewable and nonrenewable. - A forest is an example of a renewable resource. When one tree is cut down, a seedling can be planted in its place to be harvested in the future. - Oil is an example of a nonrenewable resource. Because oil is produced by nature over many millions of years, there is only a limited supply. Once the supply of oil is depleted, it is impossible to create more.

Are natural resources necessary for being highly productive?

Although natural resources can be important, they are not necessary for an economy to be highly productive in producing goods and services. Japan, for instance, is one of the richest countries in the world, despite having few natural resources. International trade makes Japan's success possible. Japan imports many of the natural resources it needs, such as oil, and exports its manufactured goods to economies rich in natural resources.

What is an important feature of capital?

An important feature of capital is that it is a produced factor of production. That is, capital is an input into the production process that in the past was an output from the production process. The woodworker uses a lathe to make the leg of a table. Earlier, the lathe itself was the output of a firm that manufactures lathes. The lathe manufacturer in turn used other equipment to make its product. Thus, capital is a factor of production used to produce all kinds of goods and services, including more capital.

If a government wishes to raise the productivity and standard of living of its citizens, it should pursue policies that:

Encourage saving and investment. If society consumes less and saves more, it has more resources available to invest in the production of capital. Additional capital increases productivity and living standards. This additional growth has an opportunity cost—society must give up current consumption in order to attain more growth. Investment in capital may be subject to diminishing returns: As the stock of capital rises, the extra output produced by an additional unit of capital declines. Thus, an additional increment of capital in a poor country increases growth more than the same increment in an already rich country. This is known as the catch-up effect because it is easier for a relatively poor country to grow quickly. However, because of diminishing returns to capital, higher saving and investment in a poor country will lead to higher growth only for a period of time, with growth slowing down again as the economy accumulates a higher level of capital stock.

If a government wishes to raise the productivity and standard of living of its citizens, it should pursue policies that: (3)

Improve health and nutrition. Expenditures on the health and nutrition of workers can significantly increase labor productivity. These expenditures are sometimes viewed as an investment in human capital, similar to expenditures on education.

If a government wishes to raise the productivity and standard of living of its citizens, it should pursue policies that: (2)

Investment from abroad! Investment from abroad can be encouraged by removing restrictions on the ownership of domestic capital and by providing a stable political environment. In addition to using domestic saving to invest in capital, countries can attract investment by foreigners. There are two categories of foreign investment. Foreign direct investment is capital investment that is owned and operated by a foreign entity. Foreign portfolio investment is capital investment that is financed with foreign money but is operated by domestic residents. Investment from abroad increases a country's GDP more than its GNP because the investing country earns the profits from the investment. The World Bank and the International Monetary Fund help channel foreign investment toward poor countries.

What is the other implication of diminishing marginal returns?

Other things being equal, it is easier for a country to grow fast if it starts out relatively poor. This effect of initial conditions on subsequent growth is sometimes called the catch-up effect. In poor countries, workers lack even the most rudimentary tools and, as a result, have low productivity. Thus, small amounts of capital investment can substantially raise these workers' productivity. By contrast, workers in rich countries have large amounts of capital with which to work, and this partly explains their high productivity. Yet with the amount of capital per worker already so high, additional capital investment has a relatively small effect on productivity.

If a government wishes to raise the productivity and standard of living of its citizens, it should pursue policies that: (4)

Protect property rights and establish political stability. Property rights refer to the ability of people to exercise control over their resources. For individuals to be willing to work, save and invest, and trade with others by contract, they must be confident that their production and capital will not be stolen and that their agreements will be enforced. Even a remote possibility of political instability creates uncertainty with regard to property rights because a revolutionary government might confiscate property—particularly capital.

What implication does the property of diminishing returns have?

When workers already have a large quantity of capital to use in producing goods and services, giving them an additional unit of capital increases their productivity only slightly. Because of diminishing returns, an increase in the saving rate leads to higher growth only for a while. As the higher saving rate allows more capital to be accumulated, the benefits from additional capital become smaller over time, and so growth slows down. In the long run, the higher saving rate leads to a higher level of productivity and income but not to higher growth in these variables. Reaching this long run, however, can take quite a while. According to studies of international data on economic growth, increasing the saving rate can lead to substantially higher growth for a period of several decades.

natural resources

inputs into production that are provided by nature, such as land, rivers, and mineral deposits.

How is productivity measured?

physical capital, human capital, natural resources, and technological knowledge

technological knowledge

society's understanding of the best ways to produce goods and services;

human capital

the economist's term for the knowledge and skills that workers acquire through education, training, and experience - this includes the skills accumulated in early childhood programs, grade school, high school, college, and on-the-job training for adults in the labor force. - Like physical capital, human capital raises a nation's ability to produce goods and services. Also like physical capital, human capital is a produced factor of production. Producing human capital requires inputs in the form of teachers, libraries, and student time.

catch-up effect

the property whereby countries that start off poor tend to grow more rapidly than countries that start off rich

productivity

the quantity of goods and services produced from each unit of labor input

physical capital

the stock of equipment and structures that are used to produce goods and services; workers are more productive if they have tools with which to work.

If a government wishes to raise the productivity and standard of living of its citizens, it should pursue policies that: (7)

Address population growth. Population growth may affect productivity in both positive and negative ways. Rapid population growth may stretch natural resources across more people. Thomas Malthus (1766-1834) argued that population growth will always rise to the limit imposed by the food supply, causing mankind to live forever in poverty. Any attempt to alleviate poverty will simply cause the poor to have more children, returning them to subsistence living. Malthus' predictions have not come true because he underestimated the ability of technological progress to expand the food supply. Rapid population growth dilutes the capital stock (both physical and human capital) by spreading it across more workers. Educated women tend to have fewer children because the opportunity cost of having children increases as opportunities grow. However, a larger population may promote technological progress. Throughout history, most technological progress has come from larger population centers where there are more people who are able to discover things and exchange ideas.

If a government wishes to raise the productivity and standard of living of its citizens, it should pursue policies that: (5)

Encourage free trade. Free trade is like a technological advance. It allows a country to transform the output from its production into products that another country produces more efficiently. The infant-industry argument suggests that developing countries should pursue inward-oriented policies by restricting international trade to protect fledgling domestic industry from foreign competition. Most economists disagree with the infant-industry argument and promote outward-oriented policies that reduce or eliminate trade barriers. Advantageous natural geography, such as good natural seaports and long coastlines, promotes trade and growth.

If a government wishes to raise the productivity and standard of living of its citizens, it should pursue policies that: (6)

Encourage research and development. Most of the increase in the standard of living is due to an increase in technological knowledge that comes from research and development. After a time, knowledge is a public good in that we all can use it at the same time without diminishing another's benefits. Research and development might be encouraged with grants, tax breaks, and patents to establish temporary property rights to an invention. Alternatively, it might be encouraged by simply maintaining property rights and political stability.