Technological Change

Importance of Technological Change to Economic Growth

Technology refers to the process a firm uses to turn inputs into outputs of goods and services.

Technological change is an increase in the quantity of output firms can produce using a given quantity of inputs.

Economic growth Opens in new window depends more on technological change than on increases in capital per hour worked.

For example, a firm’s managers may rearrange a factory floor or the layout of a retail store, thereby increasing production and sales.

Sources of Technological Change

Technological change can come from three main sources:

1.   Better machinery and equipment

Technological change is generally embodied in new machinery, equipment or software.

Beginning with the steam engine during the Industrial Revolution, the invention of new machinery has been an important source of rising labor productivity.

Today, continuing improvements in computers, factory machines, tools, electric generators and many other machines contribute to increases in labor productivity.

2.   Increases in human capital

Capital refers to physical capital, including computers, factory buildings, machines, tools, warehouses and trucks.

The more physical capital Opens in new window workers have available, the more output they can produce.

Human capital is the accumulated knowledge and skills that workers acquire from education and training or from their life experiences.

As workers increase their human capital through education or on-the-job training, their productivity will also increase. The more educated workers are the greater is their human capital.

Note that technological change is not the same thing as more physical capital. New capital can embody technological change, such as when a faster computer chip is embodied in a new computer.

But simply adding more capital that is the same as existing capital Opens in new window is not technological change Opens in new window. For example, the former Soviet Union failed to maintain a high rate of economic growth, even though it continued to increase the quantity of capital available per hour worked Opens in new window, because it experienced very little technological change.

A very important point is that just accumulating more inputs—such as labor, capital and natural resources—will not ensure that an economy Opens in new window experiences economic growth Opens in new window unless technological change also occurs.

3.   Better means of organizing

Labor productivity will increase if managers can do a better job of organizing production.

For example, the just-in-time system Opens in new window, first developed by Toyota Motor Corporation, involves assembling goods from parts that arrive at the factory at exactly the time they are needed.

With this system Toyota needs fewer workers to store and keep track of parts in the factory, so the quantity of goods produced per hour worked increases.

In implementing technological change, entrepreneurs Opens in new window are of crucial importance. In a market economy entrepreneurs make the crucial decisions about whether or not to introduce new technology to produce better or lower-cost products.

Entrepreneurs Opens in new window also decide whether to allocate the firm’s resources to research and development (R&D) that can result in new technologies.

Why Technological Change Is Important for Economic Growth

Technological change helps economies avoid diminishing returns to capital.

Let’s consider two simple examples of the effects of technological change. First, suppose you have 10 photocopiers in your photocopying store. Each of the photocopiers can produce 30 copies per minute.

You don’t believe that adding an eleventh machine, identical to the 10 you already have, will significantly increase the number of copies your employees can produce in a day.

Then you find out that a new photocopier has become available that produces 60 copies per minute. If you replace your existing machines with the new machines the productivity of your workers will increase.

The replacement of existing capital with more productive capital is an example of technological change.

Or suppose you realize that the layout of your store could be improved. Perhaps the paper for the machines is on shelves at the back of the store, which requires your workers to spend time walking back and forth whenever the machines run out of paper. By placing the paper closer to the photocopiers you will also improve the productivity of your workers.

Reorganizing how production takes place in order to increase output is also an example of technological change.