Economic productivity is a crucial determinant of living standards. That’s why some countries have a much higher standard of living than others. Thus, to understand why certain economies are more productive than others, we have to understand how productivity is determined. More specifically, there are four determinants of productivity: physical capital, human capital, natural resources, and technological knowledge. We will look at each of them in this article.
1) Physical Capital
Physical capital (i.e., capital) describes the stock of equipment and structures that are used to produce goods and services. That means it represents the tools and infrastructure workers use to create goods and services. Generally speaking, an increase in the amount or quality of physical capital leads to an increase in productivity.
To illustrate this, let’s look at a pizza baker, called John. To bake his pizzas, John uses an oven, a pizza shovel, and a few other tools. That’s considered his physical capital. Now, assume John wants to increase the number of pizzas he can bake per hour. To do this, he can buy a dough mixer. This new mixer cuts the time he needs to prepare the dough in half, which allows him to produce more pizzas more quickly. In other words, more specialized equipment increases John’s productivity.
Note that capital is considered one of the four factors of production because it is used to produce other goods and services. However, unlike the other factors, capital is a produced factor of production. That means, at some point in the past, this input was the output of a production process itself.
2) Human Capital
Human capital refers to the knowledge and skills that workers acquire through education, training, and experience. That means it includes all the relevant know-how that workers have accumulated throughout their life (e.g., school, university, training, on-the-job learning). Although it is intangible, human capital is similar to physical capital in many ways. Thus, an increase in the availability of human capital usually leads to higher productivity.
For example, John didn’t start as an experienced pizza baker. As a kid, he worked at a local restaurant as a kitchen aid. Although he mainly washed dishes and brought out the trash, he learned a lot about working in a kitchen. After finishing his high school diploma, John went to culinary school. That’s where he learned how to bake pizza. Finally, he worked as a commis at an Italian restaurant for some time to gain work experience.
3) Natural Resources
Natural resources describe all inputs into the production of goods and services that are provided by nature. That means it represents everything that can be used to create goods and services that is not humanmade. There are two types of natural resources: renewable and non-renewable. As the name suggests, renewable resources (e.g., forests, solar power) can be replenished quickly. In contrast, non-renewable resources (e.g., oil, minerals) usually take several thousands of years to be created.
Going back to our example, John uses an authentic wood-fired oven to bake his pizza. Thus, he needs a lot of firewood. Fortunately for him, wood is a renewable natural resource. Whenever a tree is cut down, a new tree can be planted in its place and grow to the same size in a few years. By contrast, a gas-fired oven uses non-renewable resources, because there is no way to replenish the gas (at least not for several thousand years).
It is important to note that the occurrence of natural resources has a significant impact on the distribution of wealth between economies and countries around the world. Although natural resources are not strictly necessary for an economy to be highly productive, they can be extremely valuable (e.g., oil) and bring great wealth and power to those who own them.
4) Technological Knowledge
Technological knowledge refers to society’s understanding of the best ways to produce goods and services. That means it basically describes technological progress within the economy. Technological knowledge can be public or proprietary. Public knowledge is openly available and can be used by all firms (e.g., computers). In contrast, proprietary knowledge is a secret and only known to the company that discovers it (e.g., Coca-Cola recipe).
In John’s case, the wood-fired oven he uses is an example of public technological knowledge. It is commonly known that the best pizza must be baked in a wood-fired, domed oven. By contrast, the secret recipe for John’s famous Garlic and Cheese Pizza is only known to him and his employees. Thus, it’s considered proprietary technological knowledge.
Please note that although technological knowledge and human capital are closely related, it is important to distinguish between the two. Technological knowledge refers to society’s understanding of how the world works, whereas human capital describes the transfer of this knowledge to the labor force.
There are four determinants of productivity: physical capital, human capital, natural resources, and technological knowledge. Physical capital describes the stock of equipment and structures that are used to produce goods and services. Human capital refers to the knowledge and skills that workers acquire through education, training, and experience. Natural resources describe all inputs into the production of goods and services that are provided by nature. And finally, technological knowledge refers to society’s understanding of the best ways to produce goods and services.