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Productivity and Human Capital

Dr. Katherine Sauer A Citizens Guide to Economics ECO 1040

Overview: I. Standard of Living Around the World II. Determinants of Productivity III. Other Factors that Influence Productivity IV. Income Inequality

I. Standard of Living Around the World

Material World By Peter Menzel

Snapshot of the Global Economy (2007)

GDP (trillions $) World Low income Lower middle income Upper middle income High income Low & middle income East Asia & Pacific Europe & Central Asia Latin America & Caribbean Middle East & North Africa South Asia Sub-Saharan Africa US EMU LDCs
Source: World Bank World Development Indicators

GNI (trillions $) 52.6 0.7 6.5 5.7 39.7 13.0 2.7 2.7 3.1 0.9 1.3 0.8 13.9 11.6 0.4

population GNI per capita (billions) ($) 6.6 1.3 3.4 0.8 1.1 5.6 0.4 0.4 0.6 0.3 1.5 0.8 0.3 0.3 0.8 7,958 578 1,887 6,987 37,566 2,337 2,180 6,051 5,540 2,794 880 952 46,040 36,329 496

54.3 0.8 6.9 6.5 40.2 14.2 4.4 3.2 3.4 0.8 1.4 0.8 13.8 12.2 0.4

II. Productivity is important because a countrys standard of living depends on its ability to produce goods and services. Productivity is the amount of goods and services a worker produces for each hour of work.

Why is America rich?

Examples of productivity improving our standard of living: - hours worked for annual food supply 1870 vs today - average work week - GDP per capita

Explain The Rule of 72

Productivity growth makes the US richer, regardless of how fast other economies are growing. Productivity growth is not a zero-sum game. India Example:

There are 4 main determinants of a nations productivity: 1. Physical Capital is the stock of equipment and structures that are used to produce goods and services. 2. Human Capital is the knowledge and skills that workers acquire through education, training, and experience. 3. Natural Resources are the inputs that are provided by nature. 4. Technological Knowledge is societys understanding of the best ways to produce.

1. Physical Capital Because capital is a produced factor of production, a society can change the amount of capital that it has. - in order to increase capital, firms must invest - firms get money to do capital investment from household savings

There is an opportunity cost of investing in capital: - use resources to produce capital - cant use those resources to produce goods or services for consumption now



physical capital capital per worker


standard of living

As the amount of physical capital in an economy increases, diminishing returns set in. If workers already have a large amount of capital to work with, giving them an extra unit will not increase their productivity by much. If workers have only a small amount of capital, then giving them an extra unit will increase their productivity more. Diminishing returns describes the situation that with more capital, output increases, but at a decreasing rate.

Output per worker

When there is low capital per worker, an increase in capital increases output per worker by a lot. When there is high capital per worker, an increase in capital increases output per work by much less.
Capital per worker

Diminishing returns helps to explain why a country like the US grows slowly while a country like China grows quickly. An important implication of diminishing returns is the catch-up effect. The Catch-Up Effect says that nations that start off poor tend to grow more rapidly than those that start off rich.




2. Human Capital encompasses a persons knowledge, ability, and skills. Most human capital is built through education and training.

Governments fund public education because a better educated population contributes to faster and sustainable development. (positive externalities) Firms invest in employee training because they expect to cover the costs through higher profits from higher worker productivity. Individuals spend time and money on higher education because they expect to earn higher wages.

Educational Attainment--People 25 Years Old and Over, by Total Money Earnings in 2008
Doctorate Degree Professional Degree Master's Degree Bachelor's Degree Associate's Degree Some college, no degree High School Graduate (inc. GED) 9th to 12th grade less than 9th grade $71,236 $60,954 $41,226 $38,676 $33,618 $24,686 $21,491 $99,995 $125,622

US Census Bureau / BLS: Current Population Survey, Annual Social and Economic (ASEC) Supplement Table from PINC-03

There may not be a return on education if - it is of low quality - the knowledge/skills learned dont match market demand - there is slow economic growth (low demand for new workers) - workers are paid the same regardless of skill (centrally planned economies)

Investing in human capital has an opportunity cost: When students are in class they arent producing (this opportunity cost is especially high in developing nations) Even when primary schooling is available, many poor children work instead of going to school. - as poverty is eliminated, child labor declines

(There exists a gender gap in education. Many girls do not go to school because of cultural norms, early childbearing, and limited employment opportunities for women. - as poverty is eliminated, the gender gap remains - national policies are needed to close the gap)

What is the problem that underlies poverty?

HS drop outs vs college grads: India: Homeless in US:

Human capital is an economic passport. Explain:

Why are fast food workers paid a relatively low wage?

Explain the relationship between the economy, human capital and the ability to find a good job.

3. Natural Resources The natural resources a nation has can help it to grow. A nation can compensate for having fewer natural resources by investing in human capital and physical capital. Just because a nation has natural resources, it is not guaranteed to grow. Policy is very important!

4. Technological Knowledge A large contributing factor for why living standards have improved over time has been due to large increases in technological knowledge. - people build human capital - people do research and development - technology advances

III. Other Factors that Influence Productivity - Foreign Investment - Health and Nutrition - Property Rights and Political Stability - Effective Government Institutions - Free Trade - Population Growth

IV. Income Inequality In the US, the poorest 20% of households were earning only 2% more in 2004 than they were in 1979. The richest 20% of households were earning 63% more in 2004 than they were in 1979. Explain this using what youve learned about human capital.

Explain what is happening to the gap between rich and poor in the US. Why is this happening?

The US economy is evolving in ways that favor skilled workers. Explain:

Explain how international trade makes US workers that are high-skilled better off and can make US workers that are low-skilled worse off.

Other Factors contributing to the wage gap: Unions: Hours worked: Performance pay:

The income gap isnt worrisome because 1) 2) The income gap might be a problem because 1) 2)

Final Thoughts: Promoting the factors that play a part in productivity and growth is a long run process. Economists differ in their views on the role of the government in promoting economic growth.

Summary: Productivity is the main determinant of a nations standard of living. Human Capital is a major determinant of productivity.

What did you learn today?

Please explain 2 concepts from todays class.