Why are some nations rich and others poor? Can the governments of poor nations do something to ensure that their nations become rich? These sorts of questions have long fascinated public officials and economists, at least since Adam Smith, the prominent Scottish economist whose famous 1776 book was titled “An Inquiry into the Nature and Causes of the Wealth of Nations.”

Economic growth matters to a country because it can raise living standards and provide fiscal stability to its people. But getting the recipe consistently right has eluded both nations and economists for hundreds of years.

As an economist who studies regional, national and international economics, I believe that understanding an economic term called total factor productivity can provide insight into how nations become wealthy.

Growth theory

It is important to understand what helps a country grow its wealth. In 1956, Massachusetts Institute of Technology economist Robert Solow wrote a paper analyzing how labor – otherwise known as workers – and capital – otherwise known as physical items such as tools, machinery and equipment – can be combined to produce goods and services that ultimately determine people’s standard of living. Solow later went on to win a Nobel Prize for his work.

One way to increase a nation’s overall quantity of goods or services is to increase labor, capital or both. But that doesn’t continue growth indefinitely. At some point, adding more labor only means that the goods and services these workers produce is divided between more workers. Hence, the output per worker – which is one way of looking at a nation’s wealth – will tend to go down.

Similarly, adding more capital such as machinery or other equipment endlessly is also unhelpful, because those physical items tend to wear out or depreciate. A company would need frequent financial investment to counteract the negative effect of this wear and tear.

In a later paper in 1957, Solow used U.S. data to show that ingredients in addition to labor and capital were needed to make a nation wealthier.

He found that only 12.5% of the observed increase in American output per worker – the quantity of what each worker produced – from 1909 to 1949 could be attributed to workers becoming more productive during this time period. This implies that 87.5% of the observed increase in output per worker was explained by something else.

Total factor productivity

Solow called this something else “technical change,” and today it is best known as total factor productivity.

Total factor productivity is the portion of goods and services produced that is not explained by the capital and labor used in production. For example, it could be technological advancements that make it easier to produce goods.