Differences in productivity

Economic Development – Differences in Productivity between Countries (Cambridge IGCSE 0455 5.4)

Learning objective

Explain why productivity and other factors differ between countries, show how these differences affect income, living standards and poverty, and evaluate the policies that can raise productivity.

1. What is productivity?

• Definition: output produced per unit of input.
• Key formulas
  • Labour productivity \[ \text{Labour productivity}= \frac{\text{Real GDP (or total output)}}{\text{Total labour‑hours worked}} \]
  • Multi‑factor productivity (MFP) \[ \text{MFP}= \frac{\text{Real GDP}}{\text{Combined input of labour + capital + other factors}} \]

2. How productivity is measured

Measure	Unit	Typical source
Labour productivity (GDP per hour worked)	USD (or local currency) per hour	World Bank, OECD
GDP per worker	USD per worker per year	National accounts
Multi‑factor productivity growth	% change per year	OECD productivity database

3. Causes of international differences in economic development (syllabus 5.4.1)

1. Productivity (labour & multi‑factor) – higher productivity raises output per worker.
2. Population growth and demographic structure – birth‑rate, death‑rate, net migration, age profile and dependency ratios affect the capital‑labour ratio.
3. Sectoral composition – share of primary, secondary and tertiary activities; services and manufacturing usually have higher productivity than agriculture.
4. Saving and investment rates – higher saving provides funds for capital formation (capital deepening).
5. Human capital – education, skills, health and work experience improve labour efficiency.
6. Physical capital & infrastructure – machinery, transport, ICT and utilities enable workers to produce more.
7. Natural‑resource endowments – oil, minerals, fertile land can boost income, but without good institutions may lead to the “resource curse”.
8. Institutional quality – secure property rights, rule of law, low corruption and efficient bureaucracy encourage investment.
9. Innovation & technology adoption – R&D, diffusion of new processes and ICT raise MFP.

4. Consequences for living standards (syllabus 5.4.2)

• Real GDP per head – the main indicator of average income; rises when labour productivity rises (holding hours worked constant).
• Human Development Index (HDI) – composite measure: \[ \text{HDI}= \frac{\text{Life‑expectancy index}+\text{Education index}+\text{GDP‑per‑capita index}}{3} \] It captures health, education and income, giving a broader picture than GDP alone.
• Advantages of a high HDI – longer life, better education, higher earning potential; disadvantages of a low HDI – poorer health, lower skills, limited economic opportunities.

5. Poverty (syllabus 5.4.3)

• Absolute poverty – living on less than a fixed threshold (e.g., US$1.90 a day); it measures the inability to meet basic needs.
• Relative poverty – living significantly below the average standard in a given society (e.g., < 60 % of median household income); it highlights inequality.
• Causes – low productivity, weak institutions, inadequate education and health, poor infrastructure, limited access to markets.
• Policies to alleviate poverty
  • Invest in education and health (raise human capital).
  • Improve infrastructure and access to credit (boost physical capital).
  • Promote good governance and property rights (encourage investment).
  • Support small‑enterprise development and trade openness.

6. Linking productivity to development indicators

Indicator	How it is affected by productivity
Real GDP per head	Higher labour productivity → higher output per worker → higher GDP per person (if hours worked are stable).
HDI	Productivity raises income component; higher income enables better health and education spending, improving the other two components.
Poverty rates	Low productivity → low wages → higher absolute and relative poverty; productivity gains can lift people out of poverty.

7. Demographic influence

Rapid population growth can dilute capital per worker (lower capital‑labour ratio) and slow productivity growth. A youthful, well‑educated workforce can raise productivity, whereas an ageing population may increase labour costs and reduce output per hour.

8. Sectoral composition

• Primary sector (agriculture, mining) – generally low productivity.
• Secondary sector (manufacturing) – moderate to high productivity, especially with automation.
• Tertiary sector (services, finance, ICT) – often the highest productivity because of high value‑added and technology use.

Economies that shift workers from primary to secondary and tertiary activities usually experience faster productivity growth.

9. Saving, investment and capital formation

• Higher gross domestic saving → more funds for investment in physical capital (machinery, infrastructure).
• Investment raises the capital‑labour ratio, directly increasing labour productivity (“capital deepening”).
• Low saving rates constrain capital formation, keeping productivity low even with a large labour force.

10. Natural resources

• Abundant, high‑value resources (oil, minerals, fertile land) can raise national income and provide funds for investment.
• Without strong institutions, resource wealth may lead to corruption, rent‑seeking and weak diversification – the “resource curse”, which depresses productivity in other sectors.
• Effective resource management (transparent royalties, reinvestment in education/infrastructure) can turn resource endowments into productivity gains.

11. Institutional quality & innovation

• Secure property rights and a reliable legal system encourage domestic and foreign investment.
• Efficient bureaucracy reduces transaction costs, making it easier to adopt new technologies.
• Government support for R&D, patents and ICT diffusion raises multi‑factor productivity.

12. Illustrative case study – Manufacturing shirts

Both countries produce 1 million shirts per year.

• Country X: 10 000 labour‑hours + automated sewing machines.
• Country Y: 25 000 labour‑hours + manual stitching.

Labour productivity:

\[ \text{Prod}_{X}= \frac{1\,000\,000}{10\,000}=100\;\text{shirts per hour} \] \[ \text{Prod}_{Y}= \frac{1\,000\,000}{25\,000}=40\;\text{shirts per hour} \]

Consequences for Country X

• Lower unit cost → higher profit margin.
• More resources available for further technology investment (virtuous cycle).
• Higher wages possible → rise in real income and living standards.

13. Policies that can raise productivity

• Education & health – improve quality and access; lifelong learning programmes.
• Infrastructure investment – roads, ports, electricity, broadband.
• Promote innovation – tax incentives for R&D, protect intellectual property, support start‑ups.
• Improve institutional environment – strengthen rule of law, reduce corruption, streamline regulations.
• Liberalise trade – expose firms to competition, encourage technology transfer.
• Encourage saving and investment – develop financial markets, offer attractive real returns.
• Manage natural resources responsibly – transparent revenue management, reinvest in human capital.

14. Evaluation – How far can productivity close the development gap? (syllabus 5.4.4)

Argument	Explanation	Example / Limitation
Strong positive impact	Higher productivity raises output per worker, so GDP per head rises even if the population grows.	East Asian “tiger” economies (South Korea, Taiwan) grew rapidly by investing in education and technology.
Institutional constraints	Without secure property rights or efficient bureaucracy, investment returns are low, limiting productivity gains.	Some oil‑rich states with weak institutions have low overall productivity.
Diminishing returns to capital	After a certain level, extra capital adds little unless matched by skilled labour and innovation.	OECD countries experience slower productivity growth despite high investment rates.
Population pressure	Rapid population growth can outpace capital formation, keeping the capital‑labour ratio low.	High dependency ratios in many Sub‑Saharan African countries keep productivity low.
Sectoral structure	Reliance on low‑value primary activities limits overall productivity.	Countries that diversify into manufacturing and services see larger productivity gains.

15. Exam‑style practice

1. Multiple‑choice (1 mark)

   Which of the following most directly raises labour productivity?
   A. Higher real wages B. More capital equipment per worker C. Larger population D. Higher inflation

2. Short answer (4–6 marks)

   Explain how a rise in human capital can lead to higher real GDP per head.

3. Data response (8–10 marks)

   Using the table below, calculate the percentage difference in labour productivity between Country A and Country C and discuss two reasons for this gap.

4. Essay (12–15 marks)

   Assess the extent to which improving productivity can reduce absolute poverty in low‑income countries.

16. Suggested diagrams for the exam

• Bar chart comparing labour productivity (USD / hour) for a high‑, middle‑ and low‑income country.
• Line graph showing the relationship between saving rate (%) and capital‑deepening (capital per worker) over time.
• Scatter plot of GDP per head versus MFP growth for a group of countries.
• Production‑possibility frontier (PPF) shift illustrating the effect of a technology improvement on potential output.

17. Summary

Differences in productivity are a core reason why some countries enjoy high incomes, low poverty and better living standards while others do not. The gap stems from variations in human and physical capital, institutions, technology, demographics, sectoral structure, natural‑resource endowments and saving‑investment rates. Policies that raise education, health, infrastructure, protect property rights and foster innovation are most effective at narrowing the productivity gap and accelerating economic development. However, the impact of productivity improvements can be limited by weak institutions, rapid population growth or over‑reliance on low‑value sectors, so a balanced development strategy is essential.