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this large variation in average income is reflected in various measures of the quality
of life. Citizens of high-income countries have more TV sets, more cars, better
nutrition, better health care, and longer life expectancy than citizens of low-income
countries.
Changes in living standards over time are also large. In the United States,
incomes have historically grown about 2 percent per year (after adjusting for changes
in the cost of living). At this rate, average income doubles every 35 years. In some
countries, economic growth has been even more rapid. In Japan, for instance, average
income has doubled in the past 20 years, and in South Korea it has doubled in the
past 10 years.
What explains these large differences in living standards among countries and
over time? The answer is surprisingly simple. Almost all variation in living standards
is attributable to differences in countries' productivity—that is, the amount of goods
and services produced from each hour of a worker's time. In nations where workers
can produce a large quantity of goods and services per unit of time, most people
enjoy a high standard of living; in nations where workers are less productive, most
people must endure a more meager existence. Similarly, the growth rate of a nation's
productivity determines the growth rate of its average income.
The fundamental relationship between productivity and living standards is
simple, but its implications are far-reaching. If productivity is the primary deter-
minant of living standards, other explanations must be of secondary importance. For
example, it might be tempting to credit labor unions or minimum-wage laws for the
rise in living standards of American workers over the past century. Yet the real hero
of American workers is their rising productivity. As another example, some
commentators have claimed that increased competition from Japan and other
countries explains slow growth in U.S. incomes in recent years. Yet the real villain is
not competition from abroad but flagging productivity growth in the United States.
The relationship between productivity and living standards also has profound
implications for public policy. When thinking about how any policy will affect living
standards, the key question is how it will affect our ability to produce goods and
services. To boost living standards, policymakers need to raise productivity by
ensuring that workers are well educated, have the tools needed to produce goods and
services, and have access to the best available technology.
Over the past decade, for example, much debate in the United States has
centered on the government's budget defic it—the excess of government spending
over government revenue. As we will see, concern over the budget deficit is based
largely on its adverse impact on productivity. When the government needs to finance
a budget deficit, it does so by borrowing in financial markets, much as a student
might borrow to finance a college education or a firm might borrow to finance a new
factory. As the government borrows to finance its deficit, therefore, it reduces the
quantity of funds available for other borrowers. The budget deficit thereby reduces
investment both in human capital (the student's education) and physical capital (the
firm's factory). Because lower investment today means lower productivity in the
future, budget deficits are generally thought to depress growth in living standards.
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