Have you encountered mobile payment systems like mobile credit card readers? Pretty cool—and this kind of innovation can be good for the economy. From micro to macro, in this episode of The Economic Lowdown Podcast Series, we'll take a look at economic growth—how innovation and technological progress can make things happen for the economy over time by organizing the factors of production to be, well, more productive.
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The other night I ate dinner with friends at a local restaurant owned and operated by someone who lives in the community. When we finished eating, the check came. But the waitress didn’t come with a typical paper check, she came with a tablet. And attached to the tablet was a small square device, not much bigger than a quarter. That device was a mobile credit card reader. Swipe your card, simple as that. Meal paid for. This type of transaction is secure, and a receipt is sent right away by email or text. It’s a truly amazing technology because it allows the point of sale—that is, the checkout process—to be mobile. Sellers can set up just about anywhere to meet the needs of buyers, giving both buyers and sellers more flexibility. Plus, that little square speeds up the checkout process. Small businesses can now enter markets more freely than ever before.
The mobile credit card reader is an example of innovation. And innovation is a driver of economic growth.
So how is economic growth measured? Well, it’s usually measured in terms of short-run economic growth and long-run economic growth.
Short-run growth, or economic expansion, occurs when total output—that is, all the goods and services produced in an economy—increases. Such economic expansion can be measured by changes in real gross domestic product, also called real GDP. Real GDP is GDP adjusted for inflation.
Long-run economic growth occurs when there is a sustained increase in real GDP over time. With long-term economic growth, the economy increases its capacity to produce. The economy not only produces more than it did before, it has the capacity to produce more.
When the output of goods and services rises at a faster rate than the population of a country, the standard of living in that country, on average, will rise. One measure of changes in the standard of living over time is real GDP per capita. This measure is calculated by dividing the real GDP of a nation by the total population. So, economic growth is necessary for us to have an increase in our standard of living.
But what specific factors lead to economic growth?
Inputs—specifically land, labor, capital, and entrepreneurship—are needed to produce more goods and services. Together these inputs are called the factors of production, which are covered in a previous podcast. So, thinking back to our restaurant example, the final goods and services supplied are the food—I had a roasted vegetable sandwich on ciabatta—and the services of the waitress, cooks, and other restaurant staff.
The restaurant owner had to rent the land, and use natural resources in order to produce these final goods and services. The owner also had to hire the labor of the chef and kitchen staff, the wait staff and manager. And this hired labor has human capital—that is, the workers have knowledge and skills obtained through education, experience, and training. Human capital is what helps the restaurant run smoothly. The chef likely had extensive culinary training, and our waitress surely had plenty of training as well—her service was excellent. The owner also had to purchase the necessary physical capital. Physical capital is the goods—the tools and equipment—used by a firm to produce other goods and services. So, in this case, the physical capital would be the ovens and cookware and tables and chairs and plates and so on. Finally, the owner had to provide entrepreneurship. An entrepreneur is an individual who is willing to take risks in order to develop new products and start new businesses. They generally recognize opportunities, enjoy working for themselves, and accept challenges. So, entrepreneurship is the ability to assume the risk of organizing factors of production to produce goods and services. Entrepreneurs pursue their plans in hopes of earning a profit. In the case of the restaurant, the entrepreneur was the owner and operator of the restaurant—he organized the land, labor, and capital to produce the food and serve the customers.
Now, let’s connect what we’ve learned about production with what we’ve learned about growth.
For the economy to grow over time, the market could employ more factors of production—more, land, labor, and capital. But, the quantities of these factors are limited, and they need to be balanced. More inputs don’t necessarily translate into more output. Imagine a tiny restaurant with 50 waitresses all clamoring to take your order—not very productive.
The biggest driver of economic gain—the force that sustains long-term economic growth—is technological progress. Technological progress increases labor productivity—that is, it increases how much work can be done in the same amount of time. Technological progress occurs when an innovation becomes widely used. Innovations include things such as new products, scientific discoveries, and improvements to management and work processes. Going back to our restaurant, how could it increase its productivity? Well, it could have better recipes—that is, better recipes for how the chefs prepare the food and how the customers pay for the food. And it could use new technology like the mobile card reader to speed the checkout process.
So, innovation—and encouragement of innovation—drives technological progress which drives economic growth.
Very often, entrepreneurs are innovators. Many develop new ideas and are often the first to use technological advancements. So, investment in human capital is vital for keeping ideas flowing. Remember, human capital is the knowledge and skills obtained through education, experience, and training.
But what encourages innovation?
What is it that encourages entrepreneurs to take on the risk of researching and developing new ideas that promote technological progress and economic growth? Well, the answer is simple: incentives that reward their productivity.
To create the incentives that motivate entrepreneurs, institutions must be developed and maintained. And by institutions, I don’t mean buildings. I mean the laws, regulations, customs, practices, and social codes that shape human interaction and structure incentives.
In the United States, there are both formal and informal institutions that support economic growth. Informal institutions include a social environment that encourages hard work, independence, self-improvement, and entrepreneurship. Informal institutions also include a stable political environment that encourages public trust in government.
Formal institutions include the laws that protect individual property rights, earnings, and investments and promote a healthy and stable financial system.
Institutions are important. Generally, in the United States, we continue to support existing institutions—and construct new ones—to incentivize the discovery of new ideas.
You may be wondering, “Incentivize? What’s that? And how do we incentivize ideas?” Well, an incentive is a benefit, reward, or cost that motivates an economic action. For example, ideas are incentivized when assurance is given that an idea will be protected—that is, that you can potentially make money by developing your idea. When economic incentives are well designed, they encourage entrepreneurs to take risks because successful innovations can generate substantial economic rewards—that is, profits.
The goal, then, is to design institutions that promote the discovery, research, development, and production of new ideas.
Suppose you have a new idea to make paying for goods and services more convenient—an idea similar to the mobile credit card reader. It can be both risky and costly to research and develop new ideas. You will likely have to form a company and hire researchers to develop the new technology. You will need to know how businesses will use the new technology and how consumers will feel about using it.
Research and development requires a huge financial investment. As a company owner, you would hope your future profits would cover your initial costs. But, say, another company, Company B, swooped in and copied your design without investing any research money. Their sales would cut into your profits. You might not even make enough to recover your initial investment. And, keep in mind, that other people will be observing what happens to your company. If your idea is so easily copied, others will most likely be very reluctant to invest any time or money into their own. Instead, they might just wait to copy someone else’s. When this is the case, little innovation will occur, little research and development will occur, and technological progress will slow considerably.
So, an incentive for developing an idea is the assurance that your idea—and your profits—will be protected. The institutions that protect property rights and incentivize ideas include patents, copyrights, grants, and prestigious awards and prizes.
Finally, for a real-life of example of innovation—of technological progress—let’s take another look at the success of the mobile credit card reader. More specifically, let’s see what it did for the restaurant in my neighborhood.
The owner regularly brings in a popular local band, which packs the restaurant to capacity and creates a long line to get in. With the mobile card reader, when customers pay with a credit or debit card—and most of them do—there is no more running back and forth to the register. The restaurant is able to “turn over” tables more quickly. That is, it is now able to serve more customers with the same amount of inputs it has experienced an increase in productivity. For the restaurant owner, the mobile card reader saves time, increases business, and ultimately, helps keep his customers satisfied.
Many other businesses have benefitted from the mobile card reader as well. Just a few that come to mind are food truck owners, antique sellers, and seasonal market vendors. What about you? How might you use the mobile card reader to start your own small business?
So, we can add the mobile credit card reader to a lineup of great historical innovations such as, vaccinations, the car, the personal computer, the internet, and social networking. Really, the mobile card reader is an extension of the Internet and social and mobile technology. But it shows us how technological progress can lead to new innovations. And I have the proof right here on my phone, with the paperless receipt for my roasted vegetable sandwich.
There are a couple ways for the economy to grow. It can use more inputs—more land, labor, capital—to produce more goods and services. Or, it can take a leap forward with technological progress and produce more goods and services with the same number of inputs. Many factors work together to promote or hinder innovation. When the proper institutions and incentives are in place, economic growth will occur over time and ultimately bump up the standard of living—and that’s good for everyone.
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