Long-run economic growth depends almost entirely on one ingredient: rising productivity. However, a number of factors affect the growth of productivity. Let’s look first at why productivity is the key ingredient. After that, we’ll examine what affects it.

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Sustained growth in real GDP per capita occurs only when the amount of output produced by the average worker increases steadily. The term labor productivity, or productivity for short, is used to refer either to output per worker or, in some cases, to output per hour (the number of hours worked by an average worker differs to some extent across countries, although this isn’t an important factor in the difference between living standards in, say, India and the United States). In this book we’ll focus on output per worker. For the economy as a whole, productivity—output per worker—is simply real GDP divided by the number of people working.

You might wonder why we say that higher productivity is the only source of long-run growth in real GDP per capita. Can’t an economy also increase its real GDP per capita by putting more of the population to work? The answer is, yes, but . . . . For short periods of time, an economy can experience a burst of growth in output per capita by putting a higher percentage of the population to work. That happened in the United States during World War II, when millions of women who previously worked only in the home entered the paid workforce. The percentage of adult civilians employed outside the home rose from 50% in 1941 to 58% in 1944, and you can see the resulting bump in real GDP per capita during those years in Figure 37.1.

Over the longer run, however, the rate of employment growth is never very different from the rate of population growth. Over the course of the twentieth century, for example, the population of the United States rose at an average rate of 1.3% per year and employment rose 1.5% per year. Real GDP per capita rose 1.9% per year; of that, 1.7%—that is, almost 90% of the total—was the result of rising productivity. In general, overall real GDP can grow because of population growth, but any large increase in real GDP per capita must be the result of increased output per worker. That is, it must be due to higher productivity.

We have just seen that increased productivity is the key to long-run economic growth. But what leads to higher productivity?

There are three main reasons why the average U.S. worker today produces far more than his or her counterpart a century ago. First, the modern worker has far more physical capital, such as tools and office space, to work with. Second, the modern worker is much better educated and so possesses much more human capital. Finally, modern firms have the advantage of a century’s accumulation of technical advancements reflecting a great deal of technological progress.

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Let’s look at each of these factors in turn.

Physical Capital Module 22 explained that capital—manufactured goods used to produce other goods and services—is often described as physical capital to distinguish it from human capital and other types of capital. Physical capital such as buildings and machinery makes workers more productive. For example, a worker operating a backhoe can dig a lot more feet of trench per day than one equipped with only a shovel.

The average U.S. private-sector worker today makes use of approximately $130,000 worth of physical capital—far more than a U.S. worker had 100 years ago and far more than the average worker in most other countries has today.

Human Capital It’s not enough for a worker to have good equipment—he or she must also know what to do with it. Human capital refers to the improvement in labor created by the education and knowledge embodied in the workforce.

The human capital of the United States has increased dramatically over the past century. A century ago, although most Americans were able to read and write, very few had an extensive education. In 1910, only 13.5% of Americans over 25 had graduated from high school and only 3% had four-year college degrees. By 2013, the percentages were 88% and 31%, respectively. It would be impossible to run today’s economy with a population as poorly educated as that of a century ago.

Analyses based on growth accounting, described later in this section, suggest that education—and its effect on productivity—is an even more important determinant of growth than increases in physical capital.

Technology Probably the most important driver of productivity growth is progress in technology, which is broadly defined as the technical means for the production of goods and services. We’ll see shortly how economists measure the impact of technology on growth.

Workers today are able to produce more than those in the past, even with the same amount of physical and human capital, because technology has advanced over time. It’s important to realize that economically important technological progress need not be flashy or rely on cutting-edge science. Historians have noted that past economic growth has been driven not only by major inventions, such as the railroad or the semiconductor chip, but also by thousands of modest innovations, such as the flat-bottomed paper bag, patented in 1870, which made packing groceries and many other goods much easier, and the Post-it note, introduced in 1981, which has had surprisingly large benefits for office productivity. Experts attribute much of the productivity surge that took place in the United States late in the twentieth century to new technology adopted by retail companies like Walmart rather than to high-technology companies.