What types of growth result from capital investment and technology?
Countries have been striving for growth for hundreds of years now. There are numerous measures for describing "growth," including freedom, happiness, and wealth. The reality is that economic growth — wealth — is the most researched area of economic success. While there are arguments in favor of gauging economic success through freedom and happiness, investigations into these areas have been limited and are not the primary focus of the individual. Rather, GDP per capita, national GDP, and average income are all measures that are used to estimate the economic success of a country.
This being said: what brings about economic growth within a country? Why are some countries better off than others? There is an infinite number of answers to these questions, but today I'd like to focus on two: capital investments and technological advancement. It may be surprising to find that in the early 1800s, the United States had a very similar average annual growth rate as almost all other countries. Today, the United States is an economic powerhouse with the highest national GDP in the world.
In the late 1800s, global GDP began to grow exponentially, but not every country was reaping the benefits. Rather, it was a select few nations that lead this global productivity expansion. What spurred this incredible growth? Capital investments. Simply put, investing money into machinery increased production. The Industrial Revolution spurred a new degree of productivity both within the United States and overseas. This, coupled with the advancements that were being made in technology, lead to growth.
While this seems pretty straight-forward, there are some underlying economic explanations for what happened between the late 1800s and today that caused global GDP to multiply over seven times. According to the Harrod-Domar model of capital accumulation, investment in physical machinery — the means of production — causes economic growth. This theory rings true at the surface, but it fails to account for diminishing returns. There is a limited amount of labor within a country. When there are only four machines, increasing the amount of capital will increase productivity! More people manning more tools will create more products. But when everyone already has a machine, adding another machine would only marginally increase the amount of productivity. So, in the short-term, capital investments lead to increased growth, but after a certain point, the diminishing return of that investment is too high for it to have an impact.
What does that mean? Well, simply that capital investment alone doesn't lead to long-term economic growth. But it does explain the spur of the Industrial Revolution and what led to economic growth in the early 1800s. So what sustains that growth? Why didn't the concept of diminishing returns apply in this situation? This is where the Solow model is introduced. This model asserts that tech advancements economize labor, increasing individual efficiency. The advancement of technology allows people to use capital over time because the capital itself changes.
However, this model is also flawed. Robert Solow was under the impression that these advancements are independent of the market. He believed that these technological progressions were a result of random scientific discoveries and creations and were not related to investment or growth.
Unfortunately, that is not an accurate depiction of technological advancement for two reasons. First, technology and innovation are a result of both demand and investment. They are not random, nor are they separate from the market. The demand for better, more efficient, higher-quality products drives these advancements through investments. What Solow failed to account for was that knowledge grows from investments into research and development. This is the primary reasoning behind research grants given by the government. Investment into knowledge leads to technological advancement. Companies, hospitals, and entities invest in better technology as a result of demand by the population for those additional or better goods and services.
To put it concisely, there are hundreds of reasons why the world and individual nations experience growth. However, there should be a degree of emphasis placed on short-term capital investments and their relation to technology. Each of the economic models suggested in this article is incomplete without the other. Together, they explain a very simple concept: investing in tools and machines (hardware) and investing in the development of these tools creates economic growth.