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Economics of Growth and Development

Notes 2.1.2 Drivers of Long Run Growth
There is a limit to how far the employment rate can be improved in the long term in developed
countries, so long term growth is driven primarily by productivity. (“Productivity isn’t everything,
but in the long run it is almost everything.” Paul Krugman). Over the longer term, growth will be
determined primarily by the factors which determine productivity, and secondly those which
improve labour participation.
The drivers of productivity growth are factors which either improve the quality of outputs, or the
efficiency with which inputs (such as capital, labour and materials) are transformed into outputs.
The contribution of some of these factors to output growth can be captured by appropriate input
measures, with everything else (e.g. unmeasured inputs and technological progress) allocated to a
residual called Total Factor Productivity (TFP).
2.1.3 Direct Inputs to Production
The main production inputs are capital, labour, management services and materials.
In the traditional Solow neoclassical growth model, a one-off increase in inputs to increase the scale
of production only has an impact on per capita output growth in the short run, while technological
progress (captured in TFP) makes a persistent contribution. However, in later endogenous growth
models, investment (particularly in innovation) drives technological progress, so has an impact on
growth in the long as well as short term.
2.1.4 Ancillary Firm Activities
Firms allocate resources to a range of activities (such as innovation, marketing, and specialisation)
which do not form direct inputs into the production process, but ultimately affect the quality of
outputs or the efficiency of input use.
Innovation by firms exploiting scientific advances creates the technological progress which is the
main driver of growth in the long run.
Specialisation in products and processes (often involving greater trade) is an important route to
increased productivity.
2.1.5 The Business Environment

There are a range of factors in the business environment (such as infrastructure, the efficiency of
markets, market incentives, taxation and regulation) which affect the productivity of firms and the
efficiency of the economy as a whole. Investment in infrastructure affects the costs to firms of
accessing resources and markets, and market conditions affect firm incentives to invest, be
enterprising and innovate.

Which factors are responsible for economic growth?

2.2 Factors of Source of Economic Growth

Capital Formation: Capital is the foremost requirement for enhancing the productive capacity of
the economy. The greater is the capital formation, greater will be the productivity of all other
factors of production, and hence greater will be the total output of goods and services in the
economy.
Empirical evidence also suggests that there is a strong positive correlation between the rate of
capital formation and the rate of economic growth. Most of the developed countries of the world
have high rates of capital formation.

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