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It is important to remember that increases in capital can take the form of both quantity and quality increases. From these two examples, it is clear that the only way to achieve labor productivity growth is to increase the amount of capital, physical and/or human, available to workers. And in the long run, the only way for overall productivity to increase is though increases in the capital used in production.
3. Changes in growth rate vs. changes in the growth level over time
Now that the growth rate vs. growth level distinction is clear, let's apply it to the way that economic policies affect productivity. The most important number in increasing economic productivity is the growth level. The growth level shows where the economy is relative to long term positioning. For instance, we know that the economy tends to grow at about 2% per year in the long run. This is the economy's growth level. When the economy grows at an increased amount, say 6% per year, the 4% difference between this and the growth level is called the growth rate. An economy with a low growth level will not grow very much in the long run even if the growth rate is high at times. For instance, over a 30-year period, an economy that has a steady growth level of 3% will far outgrow an economy that has an unpredictable growth rate but a growth level of 1%. In this way, it is important to keep both the growth rate and the growth level as high as possible, but if one is to be preferred over the other, a stable and high growth level is more desirable than an unpredictably fluctuating growth rate. Why is this distinction important? Many people are shortsighted. When politicians manipulate economic variables, they may do so to create desirable short terms effects or to create desirable long-term effects. If they enact policies that temporarily increase economic growth, then they are affecting the growth rate. If, on the other hand, they enact policies that permanently increase economic growth, then they are affecting the growth level. As long as there is not a tradeoff between policies that affect the growth level and those that affect the growth rate, there is no conflict of interest. On the other hand, if
increasing economic growth now results in relatively poorer long term economic growth, politicians may be tempted to trade an increase in their approval now for a slightly lower economic growth level. Here is where the difference between growth level and growth rate is most important, as evaluating economic interventions in the long run is difficult without employing this differentiation.
QUESTION/ANSWER SESSION:
Q.1 What is the only thing that makes an economy grow in the long run? Ans. Labor productivity growth is the only thing that makes an economy grow in the long run. Q2. How are the growth level and the growth rate different? Ans. The growth level is the starting value of whatever is growing; the growth rate is the change in the growth level from year to year. Q3. Why is the distinction between growth level and growth rate important? Ans. If increasing economic growth now results in relatively poorer longterm economic growth, politicians may be tempted to trade an increase in the growth rate (and their current approval ratings) for a slightly lower economic growth level.