To summarize, even after we eliminate differences in labor, physical capital, and human capital, much is still left to be explained. According to our production function, the remaining variation is accounted for by differences in technology—our catchall term for everything apart from labor, physical capital, and human capital.
Just as firms accumulate physical capital, they also accumulate knowledge in various ways. Large firms in developed countries develop new knowledge through the activities of their research and development (R&D) divisions. [***Gains in productivity of this form sometimes end up embodied in capital stock—think of a computer operating system, such as Windows or Linux. Such knowledge increases the value of capital stock and is already captured by looking at the ratio of capital stock to GDP.***] In poorer countries, firms may access existing knowledge by importing technology from more developed countries.
Differences in knowledge help to explain differences in output per worker. The rich countries of the world tend to have access to state-of-the-art production techniques. We say that they are on the technology frontier; they use the most advanced production technologies available. Factories in poor countries often do not use these production techniques and lack modern machinery. They are inside the technology frontier.
As economists have researched the differences in economic performance in rich and poor countries, they have found that success depends on more than physical capital, human capital, and knowledge. Appropriate institutions—the social infrastructure—also need to be in place. These are institutions that allow people to hold property and write and enforce contracts that ensure they can enjoy the fruits of their investment. Key ingredients are a basic rule of law and a relative lack of corruption. An ability to contract and trade in relatively free markets is also important.
Particularly in more advanced countries, we need the right institutions to encourage technological progress. This is complicated because there is a trade-off between policies to encourage the creation of knowledge and policies to encourage the dissemination of knowledge. Knowledge is typically a nonexcludable good, so individuals and firms are not guaranteed the rights to new knowledge that they create. This reduces the incentive to produce knowledge. To counter this problem, governments establish certain property rights over new knowledge, in the form of patent and copyright laws. Knowledge is also typically a nonrival good, so everyone can, in principle, benefit from a given piece of knowledge. Once new knowledge exists, the best thing to do is to give it away for free. Patent and copyright laws are good for encouraging the development of knowledge but bad for encouraging the dissemination of knowledge. Current debates over intellectual property rights (file sharing, open source, downloading of music, etc.) reflect this trade-off.
Differences in natural resources can also play a role in explaining economic performance. Some countries are lucky enough to possess large amounts of valuable resources. Obvious examples are oil-producing states such as Saudi Arabia, Kuwait, Venezuela, the United States, and the United Kingdom. Yet there are many countries with considerable natural resources that have not enjoyed great prosperity. Niger’s uranium deposits, for example, have not helped that country very much. At the same time, some places with very little in the way of natural resources have been very successful economically: examples include Luxembourg and Hong Kong. Natural resources help, but they are not necessary for economic success, nor do they guarantee it.
KEY TAKEAWAY
Differences in real GDP across countries can come from differences in population, physical capital, human capital, and technology.
After controlling for differences in labor, physical capital, and human capital, a significant difference in real GDP across countries remains.
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Checking Your Understanding
In ***Table 6.2 "Real GDP in 2003 in the United States, India, and Niger if All Three Countries Had the Same Workforce", Table 6.3 "Real GDP in the United States, India, and Niger if All Three Countries Had the Same Workforce and Physical Capital Stock", and Table 6.4 "Real GDP in 2003 in the United States, India, and Niger if All Three Countries Had the Same Workforce, Physical Capital Stock, and Human Capital Stock", the level of real GDP for the United States is the same as it is in Table 6.1 "Real GDP in the United States, India, and Niger". Why is this the case?
What kinds of information would help you measure differences in human capital?
How can human capital and knowledge flow from one country to another?
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