Who stimulates economic growth? The labor force, which is defined as the number of working age (ages 16-64) people available to work, both employed and unemployed plays a meaningful role. As a country’s population ages and individuals live beyond working age, the labor force declines, thus constraining potential growth. Conversely, countries with younger populations generally exhibit higher growth potential. Furthermore, fertility rates drive population growth and thereby affect future GDP. Nations with low or declining birthrates will likely face challenges from labor force declines. All of these demographics can be quantified in the Labor Force Participation Rate. This rate is defined as the proportion of working age population in the labor force. After World War II, the rate steadily climbed thanks to Americans returning to the work force and having children. The rate continued to climb throughout the end of the century as women started entering the workforce in greater numbers, topping out at 67.3% in April 2000. With Baby Boomers retiring and the younger generation delaying entrance into the workforce, the Labor Force Participation Rate has declined, bottoming in September 2015 at 62.4% and currently sitting at 62.9%. Since developed countries like the United States tend to have lower fertility rates than less developed countries, immigration represents a potential source of continued economic growth in developed countries.
What drives economic growth? Savings and investment are positively correlated with economic development and growth. For economies to grow, investment must provide a sufficient level of capital per worker. If an economy has insufficient domestic savings and investment, it must attract foreign investment in order to grow. A stable political environment that promotes property rights, low taxes and regulatory burdens, free trade and unrestricted capital flows best encourage investment.
Where to invest for economic growth? Human and physical capital are good places to start. Human capital refers to the knowledge and skills individuals possess. Increasing human capital through education and/or work experience boosts productivity and economic growth, and also leads to innovation. Physical capital investment in infrastructure, computers and telecommunications (ICT), along with machinery, transportation and non-residential construction (non-ICT) promotes labor productivity and shows strong positive correlation with GDP growth rates.
Why invest in human and physical capital? We now know that capital investment can take different forms. The most impactful capital investments influence technological progress. Investing in the IT sector has created what are termed network externalities. Investment in IT networks may have multiplicative effects on productivity since IT network investment actually becomes more valuable as greater people become connected to the network. Technological advancements play a significant role in economic growth for mature, developed countries like the United States.
When will we achieve more robust economic growth? The United States, along with other developed world economies, have low population growth, but high capital investment when compared to emerging economies. At high levels, capital investment (capital deepening) has shown diminished marginal returns to productivity. Essentially, mature economies with low population growth and already high levels of capital investment grow through technological innovation that shifts the growth curve upward. Through research and development, technological innovation can manifest itself in process, knowledge, information, machinery and software, subsequently making each individual in the labor force more productive.
And finally, there is an “H.” How do you find economic growth? Look for a stable economic and political environment with high population growth, low but increasing capital investment and technological development. You might just find growth that isn’t “lackluster”, but brilliant and dazzling.
