Policies for growth
Governments cannot command growth, but their policies shape the conditions for investment, innovation, and productivity.
Investing in people
Education and health raise human capital. Each additional year of schooling is typically associated with roughly 8-10% higher earnings for individuals, and better-educated workforces adopt technology faster. Early childhood programmes and nutrition can have especially large long-term returns.
Physical infrastructure
Roads, ports, electricity, and broadband lower the costs of doing business and connect markets. Infrastructure gaps hold back growth in many developing countries, while poorly chosen projects can waste resources. Careful project selection and maintenance matter as much as spending levels.
Research and innovation
Because ideas spill over, private firms underinvest in research. Governments fund basic research, offer tax credits for research and development, support universities, and use patents to reward invention. Spending on research and development is around 2-3% of GDP in many rich economies and higher in South Korea and Israel.
Competition and openness
Competition pushes firms to innovate and become more efficient; open trade exposes them to new ideas and larger markets. Barriers to entry, excessive regulation, and protection can shelter inefficient firms. Reforms in India from 1991 and China from 1978 that opened markets preceded rapid growth.
Macroeconomic stability
Low and stable inflation, sustainable public finances, and a sound financial system make it easier for households and firms to plan and invest. Crises, hyperinflation, and debt defaults destroy savings and confidence, often setting growth back for years.
Rule of law and property rights
Investors need confidence that contracts will be enforced and assets not seized arbitrarily. Corruption raises costs and discourages investment. Hernando de Soto argued that giving poor people formal title to land and homes they already use helps them borrow and invest, though evidence on the size of these effects is mixed.
Productivity slowdowns
Productivity growth in many advanced economies slowed after the mid-2000s, puzzling economists. Explanations include measurement problems with digital goods, weaker diffusion of technology from leading firms to others, slower business investment, and aging populations. Some hope artificial intelligence will boost productivity again; evidence so far is still emerging.
Worked example
A developing country improves its ports and customs procedures, cutting the time to export a container from 30 days to 10. Exporters become more competitive, foreign firms invest in factories, and workers move from farming into higher-productivity manufacturing. This structural transformation, as in East Asia, raises average productivity and growth.
Key takeaways
Education, health, and early childhood programmes build human capital. Good infrastructure lowers costs. Governments support research because ideas spill over. Competition and openness spur innovation. Stable macroeconomic policy and rule of law encourage investment. Productivity growth slowed in many rich economies after the mid-2000s; new technologies may help.
Flashcard
About 8-10% higher earnings per year
Check your understanding
Why do governments subsidise research even in market economies?