Intro: Profit is a reflection of productivity, which in turn depends on the availability of land labour and capital and the business environment. Profit signals to businesses that their efforts are adding value and their production is in line with consumer demands, which incentives them to produce more. .
The productivity of labour depends on the availability of savings in the economy (land and physical and human capital), and how productive businesses are at using these savings for investment, which ultimately depends on the country’s business environment. Growth in productivity tends to be reflected in the growth of profitability. If profitability in a particular country is high, this will tend to reflect a high level of productivity. Businesses will be incentivised to invest and expand, and the faster the economy will grow.
Business Environment: The most important driver of economic activity over the long term is the business environment. Generally speaking, high levels of economic freedom and political stability, and low levels of corruption provide greater profit opportunities for entrepreneurs to start businesses and create wealth. The Heritage Foundation’s Index of Economic Freedom, is closely correlated with GDP per capita, showing its importance in driving economic growth.
Savings: The more savings available in an economy, the greater the potential for businesses to find profitable opportunities for any given amount of labour. The more infrastructure, factories, mechanical equipment, office buildings, and skilled workers that exist, for instance, the more productive labour will become.
Demographics: If demographic trends suggest the working age population will rise, this is positive for real GDP growth. An increase in employment, all else equal (i.e. assuming output per worker doesn’t fall), will lead to a rise in output.
However, the increased labour supply doesn’t just create output automatically, it does so through increasing profits; the increased pool of labour leads to increased productivity of investment, boosting profitability and leading to increased investment. If, for example, looser immigration laws lead to a sharp rise in the labour force, this will increase businesses’ profitability, leading to an increase in investment and growth.
If government policy is primarily concerned with providing a free business environment, wealth redistribution efforts are minimal, monetary policy is in line with economic fundamentals, and demographics are improving, an economy will tend to grow rapidly. The free market will ensure that technological advancements allow for greater economic prosperity and recessions/financial crises will tend to be avoided or mild. It is no coincidence that the greater economic freedom, the wealthier countries tend to be.
