Definition of economic growth
Economic growth involves increasing the total output produced by resources in an economy. It
is therefore measured by an increase in the real GDP of an economy.
How economies grow
Demand for increased living standards means many governments have a macroeconomic
objective to improve their long-term rate of economic growth. Economists measure the rate of
economic growth by how much the real GDP has increased each year in an economy.
1
The discovery of more natural resources
The discovery of gas and oil has given a number of countries the ability to grow rapidly.
Indeed, the discovery of more natural resources, including
mineral deposits, such as coat and iron ore or even new varieties of fruit or cereals, can help
any economy to increase output. Searching for new natural resources, however, costs a lot of
money and some countries, particularly those in the developing world, tack the funds to do
this.
2
Investment in new capital and infrastructure
Investment by private sector firms involves spending on capital goods such as new machinery,
buildings and technology so that they can expand their scale of production, lower their
average costs and produce more goods and services in the future. Similarly, investments in
modem infrastructure such as road networks, airports and ports by governments can improve
access and communications to expand the productive potential of the economy. By lowering
interest rates, a government can make it less costly for private sector firms to borrow money
for investment.
3
Technical progress
New inventions and production processes can increase the productivity of existing resources
and produce new materials and products. Technical progress is a major driver of economic
growth.
Technological advances made in one industrial sector can often 'spill over' into other sectors.
For example, fibre-glass was originally invented for use as insulation material but is now used
in the production of bows and crossbows, roofing panels, automobile and aircraft bodies,
surfboards, artificial limbs and many more products. Similarly, the internet is based on a
system originally developed by the US Defense Advanced Research Projects Agency to enable
communications between military computers to withstand nuclear attack. Governments can
support investments in the research and development (R&D) of new products and processes,
either directly through public funding of firms and universities or by providing tax breaks for
firms that undertake R&D. They can also encourage R&D by protecting new inventions from
copy or theft through the issue of patents.
4
Increasing the quantity and quality of human resources
A larger and more productive work force can boost economic growth. Education and training
are often called 'investments in human capital' and will help create a better skilled,
knowledgeable and more productive workforce. Improvements in healthcare and medicines can
also improve the health and productivity of the workforce and reduce the number of days
they are sick and unproductive. Expanding the work force may require policies to encourage
more people into work, for example cutting income taxes and unemployment benefits, and
increasing the age at which people can retire and receive a pension from the government. The working
population of a country can also be expanded through the inward migration of skilled labour and, in
the longer term, through an increase in the birth rate.
5
Reallocating resources
An inefficient allocation of resources will constrain economic growth. Moving resources from
less productive uses to more productive uses will boost output and growth. Similarly, moving
some resources from the production of
consumer goods and services into the production of capital goods will help increase the
productive potential of an economy.
Causes and consequences of recession
The rate of economic growth is a measure of how quickly or slowly real output rises over time.
For example, in 2017 real output in India grew rapidly by 7.3%. In comparison, the US
economy grew by only around 2.6% over the same period. The rate of economic growth in an
economy, like any economic variable, can vary over time but while it remains above zero that
economy will continue to expand: real output will be increasing each year. A fall in the growth
rate, say from 5% to 2% each year, will mean real output is rising more slowly than in the
past. In contrast, an increase in the growth rate of an economy, from say 5% to 7% each year
means its real output is expanding at a faster rate than in the past.
However, economies can sometime experience periods of negative growth or falling real GDP
during: an economic recession involving a relatively short period of negative growth that may
only fast for six months or, in some cases, a year or more after which the economy recovers
and continues to grow once again; an economic depression or stump which may last several
years during which there is a continuous and substantial fall in real GDP.
What is the economic cycle?
Most governments want to achieve long-term stable economic growth in the real GDP of
their economies. Plotted on a graph over time this should look like a steadily rising line.
However, in practice the annual rate of growth in real GDP often varies considerably in the
short run and may even turn negative during an economic recession.
The business cycle or economic cycle refers to the pattern of recurrent ups and downs (or
cyclical fluctuations) observed in real GDP growth over time in many economies. Most
economies go through a fairly predictable economic cycle of changes in their rate of
economic growth every 5-10 years, some more severe than others.
Typically, an economy passes through four distinct phases during one complete economic cycle:
•
Growth
Economic activity is expanding rapidly. Many firms enjoy increased safes and profits. New
business organizations are formed. Output, incomes and employment are all growing.
•
Economic boom
Aggregate demand, sales and profits peak. There may be rapid inflation as prices rise quickly
because demand exceeds the amount of goods and services firms can produce and supply.
The economy 'overheats'. Shortages of materials, parts and equipment will increase business costs.
There is a shortage of labour.
Unemployment is low and wages rise as firms compete to employ skilled workers. The
government may raise interest rates to control rising inflation. Consumer confidence and
spending may begin to decline as inflation and interest rates rise.
•
Economic recession
There is a general slowdown in economic activity. Demand for many goods and services begins to
fall. Sales and profits decline. Firms cut back their production and workers are made redundant.
Unemployment rises and incomes start to fall, causing consumer spending to fall further. As a
result, economic growth turns negative. That is, the economy begins to shrink as economic
activity falls
•
Economic recovery
Business and consumer confidence starts to recover. Spending on goods and services begins to rise.
Safes and profits begin to rise. Firms increase their output and employ more workers. New businesses
are formed. Unemployment falls and incomes rise, boosting consumer spending further. The
economy starts to expand again.
Consequences of economic growth
Sustained economic growth can bring widespread benefits to an economy, its people, firms
and government, for example:
•
greater availability of goods and services to satisfy consumers' needs and wants
•
increased employment opportunities and incomes
•
increased sales and profits, and increased business opportunities
•
low and stable price inflation, if growth in output matches growth in demand
•
increasing tax revenues for a government, that can be invested in more and better
roads, schools, healthcare, crime prevention and other merit goods and public services
•
improved living standards and economic welfare.
However, economic growth need not improve the quality of life for everyone. While some
people may become rich, many others may remain poor and have a low standard of living.
The distribution of income and wealth in many countries is very unequal and may become more
so if the benefits of growth are concentrated among relatively few people.
In addition, economic growth can have other
negative impacts:
•
Technical progress may replace workers with machines so more people become
unemployed for long periods of time.
•
Growth might only be achieved by producing more capital goods at the expense of
consumer goods. However, are people necessarily better off if growth is achieved, for
example, by producing more weapons, cigarettes or coat-fired power stations? Equally, are
people better off simply because they have more cars, televisions and computer games?
•
Economic growth may mean we use up scarce resources at a faster rate. Oil, coat, metals
and other natural resources are limited and may soon run out. Forests may be cut down and
green space used up at an increasing rate to build more houses, roads, factories, offices and
shops.
•
Increasing production and energy use may increase noise, air, water and scenic pollution.
Marine and wildlife habitats may be destroyed killing many creatures and plants. People may
also suffer from more health problems as a result.
Economic growth can therefore involve a significant opportunity cost in terms of its social
and environmental impacts. Because of this, governments around the world are increasingly
focused on achieving sustainable growth.
Sustainable economic growth involves reducing the rate at which we use up natural resources,
reducing waste in production and consumption and reducing harmful emissions by changing
the way we produce and consume goods and services.
Policies to promote economic growth
Government policies to promote economic growth will focus on:
•
•
boosting total demand during an economic recession;
trying to increase total supply by improving long run growth in factor productivity so
that factors of production are able to produce more total output.
Demand-side policies
Using fiscal and monetary policy instruments to boost total demand will be important during
an economic recession or slump in demand.
•
A government may boos total demand by cutting direct taxes and increasing public
expenditures. Lower- income tax will increase disposable income and encourage consumer
spending. Increased spending on welfare payments will also encourage consumer spending
while increased spending on capital projects such as new road constructions will help create
new jobs by increasing business and household incomes.
•
Monetary policy may also be used to reduce interest rates to encourage higher levels of
borrowing and therefore spending in the economy. If lower interest rates fail to boost demand,
the government may also instruct the central bank to use measures such as quantitative easing
to increase the money supply in the economy.
However, boosting total demand during an economic recession will do very tittle to expand
the productive potential of the economy and its rate of long run growth. This requires supplyside policies.
Supply-side policies
Supply-side
policies
are
required
to
reduce
or
remove
barriers
that
may prevent
improvements in productivity and the productive capacity of the economy. Measures
designed to achieve this include:
•
Investing in improvements to education and training, to increase the skills,
knowledge and mobility of the current and future workforce;
•
Supporting investments in the research and development (R&D) of new, innovative
products, technologies, production processes and materials that can be used to produce more
and better goods and services;
•
Public investments in modernizing existing and building new economic
infrastructure, such as new power generation and distribution systems, mobile and
broadband communications networks, roads, airports and ports, all of which will directly
benefit many firms, the process of production and the movement of people, goods and services
within an economy;
•
Giving tax cuts and subsidies to new firms to encourage people to start new businesses;
•
Encouraging multinationals to locate and invest in the economy thereby boosting
output and providing additional jobs;
•
Plus other measures aimed at improving resource efficiency including privatization,
deregulation, towering income taxes to improve work incentives and labour market
reforms.
The main problem with supply-side policies is that they can take a considerable time to work.
For example, major infrastructure projects often take many years to build and it may also take
several years for investments in education to lead to higher labour productivity. Such investments
also tend to be very expensive. A government may have to increase taxes and/or its borrowing
to pay for them. Both actions are likely to reduce or crowd out private sector spending. Unless
there is sufficient demand in an economy for their goods and services, firms will be reluctant
to increase production and set up new businesses.