What is a knowledge economy?
Every economy uses factors of production: land, labour, capital and enterprise. In an old, farm or factory economy the biggest share of output came from land and machines. In a knowledge economy the biggest source of growth is knowledge: skills, new ideas, research, design, software and know-how.
Signs of a knowledge economy: many skilled workers, high spending on education and research, many new products and patents, strong use of computers and the internet, and a large share of jobs in services such as IT, finance, health and design.
Human capital
Human capital means the skills, knowledge and health of workers. A person who learns more can do harder work, make fewer mistakes and earn more. Human capital grows through:
- Education at school and college.
- Training on the job.
- Health, because a healthy worker can work and learn better.
Spending on these is an investment, not just a cost. It pays back later as higher output and higher wages. Unlike a machine, skills do not wear out by use; they grow when used, but they need to be kept fresh. Migration of skilled people ("brain drain") can lower the human capital of the country they leave.
Innovation and new ideas
Innovation is turning a new idea into something useful: a new product, a better way of making things or a new service. It comes from research and development (R&D).
Ideas behave differently from land or machines. One person using a machine stops another from using it at the same time, but an idea can be used by many people together. It can also be copied at very low cost. That is why ideas can produce increasing returns: the more people use a good idea, the more total benefit. To make people invest in new ideas, governments give patents, which give the inventor sole rights for a time.
Governments and firms also support innovation through universities, research grants and start-up help.
The information society
In an information society, creating, sharing and using information is the main economic activity. ICT (information and communication technology: computers, phones, the internet) makes it quick and cheap to move information across the world.
- Firms can work with teams in many places.
- People can learn online and find jobs far from home.
- New businesses such as online shops, apps and digital services appear.
There are also problems. The digital divide is the gap between those who can use ICT and those who cannot. Some jobs are lost to automation, and personal data must be kept safe. Good policy means giving everyone access and teaching digital skills.
Try it
In the 3D, set education to 0 and research to 0, then raise only one at a time. Which gives the bigger rise in output? Then raise both. At home, list five jobs in your area that exist because of the internet and five that need long training.
Key formulas and definitions
- Output grows with: land + machines + skilled people + ideas + information flow.
- Human capital = skills + knowledge + health of workers.
- R&D spending (%) = R&D spending / GDP × 100
- Innovation = new idea turned into a useful product or method.
Worked examples
1. Why is spending on a school called an investment in human capital?
Because it makes future workers more skilled. They will produce more and earn more later, so the spending pays back over time.
2. A country has GDP of 500 billion dollars and spends 2% of it on R&D. How much is that?
2% of 500 = 0.02 × 500 = 10 billion dollars.
3. Why can one idea be used by many firms at once, but one machine cannot?
An idea is not used up and can be copied at low cost, so many can use it together. A machine is a physical object, so only one user at a time can use it.
4. A firm pays 20,000 for training that raises a worker's yearly output by 8,000. After how many years does the training pay for itself?
20,000 / 8,000 = 2.5 years.
Common mistakes
- Thinking a knowledge economy has no farms or factories. It still has them, but knowledge raises their output.
- Thinking human capital means only a degree. Training and health count too.
- Saying an idea is used up when others use it. Ideas can be shared and copied.
- Confusing information (data) with knowledge. Knowledge means being able to use the information.