How does capital deepening contribute to economic growth?

 Capital deepening refers to an increase in the share of capital stock in the number of hours employed. Movements in this ratio are closely related to labour production movements, all other items held to be equal. A rise in capital per hour (or an increase in capital) contributes to an increase in labour productivity. 

Remember the factory staff in a motor car facility, for example. If employees have improved access to equipment and automotive building materials, they can build more cars in the same amount of time. Capital deepening often usually contributes to an increase in the growth rate of overall production. Capital deepening is also thought to be a key – if not a prerequisite – factor for economic growth in emerging markets. 

During recessions, the labour time dropped, but capital stayed stable in the short run leading to a rising capital per hour (or, in other words, capital deepening). This was true during the Great Crisis when wealth spiked at the hour of labour. Since the crisis, the hours rose, allowing capital to decline to worsen. 

Usually, spending rises during the recovery period of the business cycle as business expenditure ramps up. Capital deepening usually improves performance by technical innovations (such as faster copying) that allow higher production per worker. In brief, deepening resources increases labour efficiency.

The capital-to-work ratio rose from a low post-recession era but remains at a rather low level. The average growth rate is actually below 0.5 per cent and has been in the decline since the end of 2007-09. Seven years of growth is less than 0.5 per cent at the end of 2017, the lowest in the history of the sequence.

Common growth models such as the Solow Growth Model suggest that capital and labour are complementary to the development process. It is a rather rigid statement and it avoids situations where labour and capital serve as substitutes in the manufacturing process – for example, machines and manual labour may act as substitutes in the production of vehicles. New models of development seek to differentiate between skilled labour and unskilled labour. 

However, in the context of the Solow Growth Model, capital and labour must be mixed in order to produce production. Ideally, deepening wealth is a bonus for both capital and labour. The influx of new capital into the manufacturing chain raises productivity, which increases labour value. 

Business benefits from more cost-effective production. Hopefully, labour gains will also come when an organisation with increased profits paying its workers better salaries. This helps the economy as a whole, as employers now have more surplus money to consume goods and services. 

Think of a farm that uses labour (farmers) and resources (tractors and harvesters) to generate production (wheat). Suppose that the farm uses 100 farmers and 10 tractors to produce 2,000 tonnes of wheat a year. If we assume that the output function of the farm satisfies the normal assumptions, then adding one more tractor will make the farmers more profitable. Replacing old tractors with more technologically sophisticated tractors that can perform more work in a shorter period will also increase productivity.

If the capital-labour ratio increases, the marginal value of labour, i.e. the quantity of product that can be generated by providing one more unit of labour, increases. The economy is currently running in a low-productivity environment. 

One reason may be a decrease in labour productivity when highly trained baby boomers retire and are replaced by younger, less experienced millennials. The clarification, however, does not say the whole tale. Capital deepening is an important component of production, and traditionally low capital growth per hour is likely to lead to the current low productivity situation.