Capital expenditure
In the previous section we learned that
increasing capital, both human and physical, is the only way to create
productivity growth in the long run. One way to directly increase the
amount of capital in an economy, also called the capital stock, is by
increasing the spending on capital.
In order to understand how increasing the spending on capital works, it
is necessary to understand how money is spent on capital. In order for
most firms to increase their capital stock, they must purchase additional
machinery, tools, and education for their employees. Because firms do
not often have the large sums of cash necessary for these types of
purchases readily available, they must go to banks to get funding for
their capital expenditures. Remember that when banks make loans, they
are simply matching up savers and borrowers. Thus, the amount of savings
by individuals directly affects the amount of money available for capital
expenditures by firms. In this way, the savings rate in a country is
the single most important determinant of the expenditures made by firms on capital.
How much money should be saved in an economy and how much should be invested
in capital? This question is difficult to answer. Some countries, like
Japan, have very high savings rates. Others, like the US, have very low
savings rates. In both cases, the exact effect on the growth of productivity
is unclear. In general, the savings rate that corresponds to the golden
rule level of capital is considered optimal. This is defined as the savings
rate that maintains the level of capital associated with the higher per worker
consumption rate. In general, a savings rate that is as high as possible
without significantly reducing the standard of living of the population
is desirable.
Regardless of the savings rate, expenditures on capital directly affect
the growth rate of an economy. They inject the economy with new tools,
machinery, and training. These forms of capital are basic necessities
of production. For a given amount of labor, such an increase in
capital will increase possible output.
Technological progress
Of course, spending money to simply increase the amount of capital in an economy
is not the only way to increase productivity. Increases in the quality of capital
can also affect growth. The major way the quality of capital is increased is through
technological progress, the fruit of research and development. Technological
advances can allow a given unit of capital to enable a given unit of labor to
increase production. This increase is contrasted to the increase created by
simply enlarging capital expenditures. In the latter case, a given unit of labor
has more capital to work with and can thus produce more output; while in the former
case a given unit of labor can produce more output with a given unit of capital.
How does technological progress come about? The major ways are though
innovation and invention. Every year, billions of dollars are spent on
research and development by firms and government agencies, like NASA. This
money leads to improvements in existing technology and to the creation of
new technologies. While innovation and invention may not always be immediately
profitable, in the long run they can prove very lucrative for the researchers
and the developers--as well as for the economy as a whole, as new, more efficient
production technologies become available.