Productivity and growth Productivity is measured by:

Employment and Labor Productivity Real GDP Slope = productivity = $66,666 Slope = productivity = $70,000 Productivity is given by the slope of a line from the origin to a point on the production function $8 Trillion B A $7 Trillion 100 120 Millions of Workers

Shifts of the Aggregate Production Function Increase in the stock of human capital Increase in the stock of physical capital Technical change Real GDP productivity = $80,000 H $8 Trillion B $7 Trillion A productivity = $70,000 100 120 Millions of Workers

Enlarging the stock of human capital means allocating scarce resources for education and training. There is an opportunity cost for both individuals and society.

Providing resources for education and training entails a short-run trade-off. B All other goods Education and Training

Net investment raises the capital to labor ratio, ceteris paribus Net investment raises the capital to labor ratio, ceteris paribus. This boosts productivity Real GDP ($ Trillions) Employment (millions)

But production of capital goods involves trade-offs too All other goods Capital goods

Policies to stimulate investment Increase incentives to invest Reduced corporate profit taxes. Investment tax credits Increase incentives to save: Reduce taxes on capital gains. Tax consumption Government Deficit Reduction

An Increase in Investment Demand Interest Rate 5% 3% I2 = New Demand for Funds I1 = Original Demand for Funds 1.5 1.75 2.25 Funds ($ Trillions)

An Increase in Saving Interest Rate B F 5% C 3% Investment Spending S1 = Original Supply of Funds S2 = New Supply of Funds B F 5% C 3% Investment Spending 1.75 2.25 2.5 Funds ($ Trillions)

Reduction of the Government Deficit Interest Rate Supply of Funds (Saving) Deficit is reduced from $.75 trillion to zero E A 5% B 3% Investment Spending + Deficit Investment Spending 1.0 1.5 1.75 Funds ($ Trillions)

Professor Solow has claimed that about 2/3 of the growth of real GDP per head in the the U.S. can be explained by technical innovation Robert Solow. “Technical Change and the Aggregate Production Function, 1919-1954,” Review of Economics and Statistics, November 1957.

Productivity boosting innovations Steam engine Electrification The assembly line Continuous process manufacturing The telephone Internal combustion engine Air conditioning Cotton harvester The transistor The computer Electronic data interchange Robotics Genetically-modified seeds Internet browser software

Source: www.bls.gov

Policies to Stimulate Innovation Tax credits to provide incentives for private research and development Give incentives to the pursuit of careers in science and engineering Public funding of R & D Legal protections of intellectual property rights—e.g., issuance of patents.

R & D absorbs scarce resources All other goods Research and Development