Effects of Investment in Physical Capital, Human Capital, and Technological Development on Economic Growth

Human Capital

Human capital is the amassed knowledge and skills that the labor force reaps from education, training, or life experiences. In other words, human capital is the “labor quality of the labor quantity.” Better educated and skilled workers will tend to be more productive. Further, such workers easily conform to ever-changing technology or shift forces in the market, such as demand and supply.

Human capital is boosted through investment in formal education and on-the-job training. Although investment in education is expensive, workers with more education earn higher wages. Moreover, increasing literacy in a person has a “spillover” effect. This means that improved education in one person increases the output of that person and those around them.

Most importantly, increased formal education and on-the-job training result in a permanent increase in the economy’s growth rate. This, strictly speaking, is the case if an educated workforce comes up with more innovations and quicker technological progress.

Physical Capital

Physical capital is any human-made good that is used in the production process. Examples of physical capital include cash and equipment. Physical capital will consistently increase if the gross investment is less than the capital depreciation, i.e., net investment is positive. This implies that countries with elevated investment spending rates should see high physical stock and a higher GDP growth rate. In other words, the correlation between economic growth and investment is high.

Categories of Capital Spending (Investments)

1. Information Communication Technology (ICT) Investment

   In most developed countries, improved information technology (technological innovation) increases economic growth rate. The use of IT equipment in economic activities causes network externalities. Network externality is where many people are interconnected through the internet, enabling them to work effectively.

2. Non-ICT Investment

   Non-ICT investment includes transport equipment and machinery. An increase in non-ICT investment results in capital deepening, which has less impact on the potential GDP growth rate than the rising share of the ICT investments.

Technological Development

Technological development refers to the discovery of new and improved methods of producing goods and services. The impact of technological progress is felt more in developed countries than in developing countries.

Effects of Technological Progress on Economic Growth

1. It enables an economy to exceed the limits imposed by diminishing marginal returns, resulting in an increased production function.
2. Production of high-quality goods and services with the same inputs results in new goods and services.
3. Technological development helps improve an organization’s efficiency and business management.
4. Technological changes are incorporated into human capital. When there is improved technology, it is reflected in human capital, making it more productive.

Question

The economy of a particular country has the following characteristics:

1. Well-educated workforce.
2. Soaring levels of savings and investments.
3. Minimal natural resources.
4. Low tariffs on imports.

An investor intends to invest in public debt in this country. The investor seeks advice from an investment analyst, who makes the following remarks:

“Over the next decade or so, the sustainable economic growth rate for this country will be impacted by an increasing proportion of the population over the age of 65 and a declining percentage below age 16, and low immigration.”

Based on the analyst’s forecast, after the next ten years, the potential GDP growth rate for this country will most likely be:

1. Unchanged.
2. Higher.
3. Lower.

Solution

The correct answer is C.

After ten years, this country is expected to have an increased population of over 65 and a declining percentage below age 16. Keeping everything else constant suggests slow growth of the labor force and a slow growth rate of potential GDP. Even though immigration counteracts these demographic constraints, the analyst suggests low migration in the future.

Reading 9: Economic Growth 

LOS 9 (h) Explain how investment in physical capital, human capital, and technological development affects economic growth.