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When looking at what makes an economy grow in the long run, it is imperative to begin by examining how output is created. Firms use a combination of labor and capital to produce their output. Labor consists of the workers and employees who produce, manage, and process production. Capital describes both the ideas needed for production and the actual tools and machines used in production. Ideas and other intellectual property are called human capital. Machinery and tools are called physical capital.
Firms use some combination of labor and capital to produce output. In particular, the labor utilizes the capital in the production process. For example, when making cars, workers use tools and an assembly line to produce a finished product. The workers are the labor and the machines are the capital.
In order to increase productivity, each worker must be able to produce more output. This is referred to as labor productivity growth. The only way for this to occur is through an in increase in the capital utilized in the production process. This increase can be in the form of either human capital or physical capital.
An example will help to illustrate the basic way that labor productivity growth works through increases in the capital stock. Say there is a riveter named Joe. Joe works in a factory that makes metal boxes that are riveted together. He has a riveting tool that can rivet at a rate that allows Joe to finish 4 metal boxes every hour. Joe's labor productivity is thus 4 boxes per hour. One day, Joe gets a second riveting tool. With two tools, Joe can produce 8 metal boxes every hour. Now Joe's labor productivity has increased from 4 boxes per hour to 8 boxes per hour. The increase in the physical capital available to Joe, that is, a second tool, allowed this increase in Joe's labor productivity. For every hour of work Joe puts in, he can produce 100% more output due to an increase in the physical capital available to him.
Another example may also be of use. Say there is a chef named Susan. Susan can cook 10 hamburgers in an hour. One day, she decides to go to the Hamburger Cooking School to learn how to cook hamburgers faster. When she returns to work, she is able to cook 40 hamburgers per hour by utilizing the new tricks she learned. By attending the cooking school, Susan increased her human capital and thus increased her labor productivity.
It is important to remember that increases in capital can take the form of both quantity and quality increases. From these two examples, it is clear that the only way to achieve labor productivity growth is to increase the amount of capital, physical and/or human, available to workers. And in the long run, the only way for overall productivity to increase is though increases in the capital used in production.
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