Stages of economic development

Historically, most of the advancements in growth have been associated with increased productivity. That, however, is not true for all countries at all times.

Less developed countries grow primarily through investment in capital and incorporating more people into their labor force. The rapid rates of industrialization in Asia can be largely attributed to investment in new equipment and expanding the work force.

See on the chart that China invests a much larger percent of its GDP in new plant and equipment compared to the U.S.

When countries develop, their pattern of economic growth begins to shift. Innovation, and not imitation, becomes more important. Hence, economic growth requires new technology and improvements in productivity.

See on the next chart the difference in labor productivity between the U.S. and China. The average U.S. worker produces much more output compared to the average Chinese worker.
Whether or not a country is able to make the transition to high productivity growth depends on many factors. Innovation requires a well educated population, strong protection of patents and copyrights, well functioning financial markets that can finance new ideas, and institutions that support the growth of new ideas. Without those factors, development reaches a ceiling and further improvements are tough to generate.


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