Productivity Growth

   What increases labor productivity? Research on this question usually divides changes in labor productivity into three sources: capital deepening, increases in skill, and efficiency gains.

   Capital Deepening.

   Capital deepening happens when businesses invest in more or better machinery, equipment, and structures, all of which make it possible for their employees to produce more. Matching employees with better capital increases the number of goods employees produce in each hour they work. Examples of capital deepening include the purchase of more sophisticated machine tools for workers in the manufacturing sector, or a faster computer system for a travel agent. A business may add capital when it increases its workforce-for example, a travel agency might buy additional computers when increasing the number of travel agents it employs-but that does not constitute capital deepening if the amount of capital available per worker does not increase.

   Farming provides a classic example of the benefits of using more and better capital. In 1830, it took a farmer 250 to 300 hours of work to produce 100 bushels of wheat; in 1890, with the help of a horse-drawn machine, the time dropped to between 40 and 50 hours; in 1975, with the use of large tractors and combines, the 100 bushels could be produced in just 3 to 4 hours. While it is most likely that farmers were more educated in 1975 than they were in the 1830s, the change in the farmers skills alone could not be the source of this dramatic efficiency gain; an important source is the use of better capital. Changing from a hoe to the tractor would be categorized as capital deepening, and the resulting increase in output is capital deepening's contribution to productivity growth.

   Increases in Skill.

   Just as a worker who is paired with a better machine can produce more goods, a worker who learns a skill needed for production can produce more output in less time. For example, a worker who takes a class on how to use a computer increases the skill with which she uses the computer; the computer is no faster, but the worker's increased skill increases her output per hour worked and hence boosts her productivity. Workers increase their skills through additional education, training, on-the-job experience, and so on.