The Secret of Economic Growth and Development

What is the secret of economic growth and development?*

Wealth is created when certain inputs are combined to produce some useful/valuable output. These inputs, or factors of production, are:

1. Land – Natural resources (soil, water, sunlight, coal, iron ore, etc)
2. Labour – The human input of production
3. Capital – Physical inputs of production (ploughs, tractors, computers, etc)

To increase the wealth created, we must increase the amounts of the inputs. A country grows or develops economically when its factors of production increase. Let us look at each factor.

Land is more or less fixed, so we will ignore it.

Labour has two aspects – quantity and quality. Quantity has no effect on wealth – the increase in production due to more labour is cancelled out out by the increase in consumption. Quality of labour is determined mainly by two things: education and health. The more educated and healthier a worker, the more he/she produces.

Some capital is privately owned, like machines and factories. Some capital is publicly owned, like roads and electricity. Publicly owned capital is nothing but infrastructure, which is provided by the government. Privately owned capital is due to investment, which is funded by savings.

However factors of production by themselves are not everything. How effectively the factors of production are combined to produce output is also important. This effectiveness is called productivity.

Now productivity consists of two parts:
a) The knowledge of how to combine the factors of production.
b) The effectiveness with which this knowledge and the factors of production are combined.
(Yes, there is a little hair splitting here)
The first we call technology. The second we call efficiency.

Knowledge/technology is a result of research and development (R&D). Efficiency is an outcome of a country's economic policies and institutions.

We can thus summarise the determinants of economic growth:
A. Factors of Production
a) Labour
1. Education
2. Health
b) Capital
1. Infrastructure
2. Savings
B. Productivity
1. Knowledge
2. Efficiency

Or we can simply list the key requirements for economic development:
1. Education
2. Healthcare
3. Infrastructure
4. Savings
5. Knowledge
6. Efficiency

*This framework is from "Economic Growth" (2009) by David Weil.