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Economic Growth
Author: Geoff Riley Last updated: Sunday 23 September, 2012

Introduction
What is meant by economic growth? Economic gro th is a long-term expansion of a countrys productive potential $hort term gro th is measure! b% the annual & change in real national output ' this is mainl% !riven b% the level o( aggregate !eman! )*+,+-+./M0 but is also a((ecte! b% shi(ts in $RA$ 1ong term gro th is sho n b% the increase in tren! or potential -23 an! this is illustrate! b% an out ar! shi(t in a countr%4s long run aggregate suppl% curve )1RA$0

#here are big variations in average gro th rates (or !i((erent countries an! evi!ence (or this is sho n in the chart above hich tracks real -23 changes (or *hina5 ,n!ia5 the 675 6$A an! average gro th (or nations insi!e the Euro 8one9 *hina an! ,n!ia are examples o( ver% (ast/gro ing countries9 #heir annual gro th has (ar excee!e! that (or most a!vance! economies: *hina has out/pace! ,n!ia although both have

experience! a slo !o n in gro th over the last couple o( %ears For nations such as the 6$A an! the 675 ;normal gro th< is o( the or!er o( 2 ' =& per %ear ' !epen!ing on here each econom% is in their business )tra!e0 c%cle9 #he Euro 8one gro th rate is similar but keep in min! that this is an average5 there are seventeen countries at present ho share the same currenc%5 some have been gro ing >uite >uickl% an! others have struggle! to escape (rom a !eep recession an! the persistent risk o( a !epression9

Economic Growth and the Production Possibility rontier

An increase in long run aggregate suppl% is illustrate! b% an out ar! shi(t in the 33F

,n our !iagram e see ho a rise in a nation4s pro!uctive capacit% causes the 33F to shi(t out an! this allo s increase! suppl% both o( consumer an! capital goo!s9 Where the econom% en!s up !epen!s on the !ecisions ma!e about the allocation o( scarce resources bet een pro!ucts to be bought an! consume! to!a% an! the pro!uction o( capital goo!s such as ne technolog%5 plant an! e>uipment an! buil!ings9 Growth is not the same as development! #he table belo tracks the gro th rates achieve! in the orl! econom% (or three recent %ears an! also (or !eveloping countries exclu!ing *hina an! ,n!ia9 "eal G#P growth $annual % change& Worl! Econom% 2?@? A9@ 2?@@ 29B 2?@2 29C

2eveloping countries exclu!ing *hina an! ,n!ia 'ey drivers of growth

C9D

A9A

=9D

#here have been numerous research stu!ies in hat !etermines long term -23 gro th Ever% countr% is !i((erent5 each (actor ill var% in importance (or a countr% at a given point in time Remember too that in our increasingl% inter/connecte! globalising orl!5 economic gro th !oes not happen in isolation9 Events in one countr% an! region can have a signi(icant e((ect on gro th prospects in another

(dvantages of Economic Growth @9 )igher living standards ' i9e9 an increase in real income per hea! o( population 29 Employment effects / gro th stimulates more Eobs to help ne people as the% enter the labour market In the long term, an economy grows because technology gets better and we get better at producing things In the short term, growth is an indication that the economy is producing as much as it could be and resources are not being needlessly wasted !ith a growing population and rising wages, the economy has to grow to create sufficient new "obs #rofessor $on %on Reenan, &S' iscal dividend ' sustaine! -23 gro th boosts tax revenues an! provi!es the government ith extra mone% to improve public services such as e!ucation an! healthcare9 ,t makes it easier (or a government to re!uce the size o( a bu!get !e(icit @9 Investment - the accelerator effect / rising !eman! an! output encourages investment ' this sustains gro th b% increasing long run aggregate suppl% 29 *onsumer and business confidence / gro th has a positive impact on business pro(its F con(i!ence9 A stronger econom% ill help to persua!e consumers that the time is right to make maEor purchases =9 -ro th can also help protect the environment such as lo /carbon investment5 innovation an! research and development5 resulting in more e((icient pro!uction processes to re!uce costs9

Ethical consumerism an! corporate social responsibility has become important in recent %ears9 +irtuous circle of growth

#isadvantages of economic growth #here are economic and social costs o( a (ast/expan!ing econom%9 Inflation ris,G ,( !eman! races ahea! o( aggregate suppl% the scene is set (or rising prices9 Man% (ast gro ing !eveloping countries have seen high rates o( in(lation in recent %ears5 a goo! example is ,n!ia Wor,ing hours ' sometimes there are (ears that a (ast/gro ing econom% places increasing !eman!s on the hours that people ork an! can upset ork/li(e balance -tructural change ' although a gro ing econom% ill be creating more Eobs5 it also lea!s to structural changes in the pattern o( Eobs9 $ome in!ustries ill be in !ecline hilst others ill be expan!ing9 $tructural unemplo%ment can rise even though it appears that a countr% is gro ing ' the labour (orce nee!s to be occupationall% mobile9 Environmental concernsG Fast gro th can create negative externalities (or example higher levels o( noise pollution an! lo er air >ualit% arising (rom air pollution an! roa! congestion ,ncrease! consumption o( !e/merit goo!s hich !amages social el(are ,t can lea!s to a huge increase in househol! an! in!ustrial aste hich again creates external costs (or societ% -ro th that lea!s to environmental !amage ma% lo er the sustainable rate of growth9 Examples inclu!e the !estruction o( rain (orests through deforestation5 the over-exploitation of fish stoc,s an! loss of natural habitat an! bio/!iversit% create! through the construction o( ne roa!s5 hotels5 retail malls an! in!ustrial estates9

#eforestation releases more *H2 into the atmosphere each %ear than all o( the orl!Is planes5 trains an! automobiles put together9 -loball%5 an area almost the size o( Englan! an! Wales is cut !o n ever% %ear releasing billions o( tons o( *H2 into the atmosphere9 .sing-up scarce resources ()he conse*uences of en+ironmentally unsustainable production are already +isible Increased e,posure to drought, floods and en+ironmental stress is a ma"or impediment to reali-ing people.s aspirations/ Source: 012# Report, 2011 #he orl!4s resources are limite!5 an! recognizing this (act an! tr%ing to preserve them (or (uture generations is vital (or sustainable gro th9 Hur rampant use o( oil has run man% reserves !r% an! each %ear it becomes more !i((icult to (in! ne oil (iel!s9 Even ater5 hich so man% people take (or grante! ill become a scarce resource5 like man% other ra materials9 Accor!ing to the 6nite! Jations5 b% 2?2C @9Kbn people ill be a((ecte! b% water scarcity9 #he pollution cause! b% economic gro th is another concern9 #he $tern Report highlighte! the !angers o( our !isregar! (or the environment5 especiall% large *H2 emissions9 ,t is pre!icte! that man% species ill become extinct as (orests an! Eungles5 homes (or man% animals5 are cut !o n to pave a% (or the gro ing orl! population9 At present @D5??? species are threatene! to!a%9 ,n @L?? accor!ing to the 6J4s -lobal Environmental Hutlook5 there ere B9L@ hectares per person5 hile it is estimate! that there ill onl% be @9D= b% 2?C? i( present tren!s continue9 Economic Growth and Ine/uality 34lthough economic growth in 5hina has created +ast wealth for some, it has amplified the disparities between rich and poor 4lthough the a+erage wealth per 5hinese citi-en was 617,128 9 almost double that of other high growth economies such as India 9 median wealth was "ust 68,327 In 2010, 5hina:s Gini9coefficient stood at 0 ;7 Ine*uality in 5hina has now surpassed that in the 0nited States 3 Source: 2r 2amian )obin School of <riental and 4frican Studies Jot all o( the bene(its o( gro th are evenl% !istribute!9 A rise in real -23 can li(t millions o( people out o( absolute poverty but it can o(ten be accompanie! b% i!ening income and wealth ine/uality in societ% that is re(lecte! in an increase in relative poverty ,( ine>ualit% gro s as a countr% becomes richer5 this raises important >uestions about a potential tra!e/ o(( bet een e>uit% an! e((icienc% #he Gini coefficient is one a% to measure the ine>ualities in the !istribution o( income an! ealth in !i((erent countries9 #he higher the value (or the -ini co/e((icient )the maximum value is @05 then greater the ine>ualit%9 *ountries such as Mapan5 2enmark an! $ e!en t%picall% have lo values (or the -ini coe((icients hereas A(rican an! $outh American countries have an enormous gul( bet een the incomes o( the richest an! the poorest elements o( the population9 When economists look at !ata on income an! income ine>ualit% the% nearl% al a%s (ocus on me!ian rather than mean incomes per capita9 #he reason is that the ver% uneven !istribution o( income means that there are people ho earn astoun!ing salaries an! ages an! the income o( the super/rich ten!s to !rive up mean incomes9 For example5 ,n the 6nite! $tates5 mean income is almost a thir! higher than me!ian income5 an! the gap is gro ing

Ine*uality in the 0= in 2011: >ouseholds below a+erage income 1?@ of children A2 3 millionB in households with incomes below 80 per cent of medium disposable income 1C@ of worDing9age adults AC C millionB had incomes below 80 per cent of medium disposable income 17@ of pensioners A2 0 millionB had incomes below 80 per cent of medium disposable income Wh% !oes (ast gro th o(ten lea! to a widening of ine/ualities in both !evelope! an! !eveloping countriesN Oer% high increases in the pa% o( people in the top/pa%ing Eobs ' market/base! economies o((er the highest re ar!s to househol!s ith the most valuable skills5 e!ucation an! access to capital ,ncreasing ealth inclu!ing rising propert% prices ' (ast/gro ing economies ill o(ten seen a rapi! increase in propert% prices -ro ing gaps bet een urban an! rural areas ith rural povert% on the increase Pigh (ertilit% in the poorest househol!s 1inke! e((ects o( ine>ualit% in health an! e!ucation Much !epen!s on the extent to hich a particular government has a el(are bene(its an!Qor a progressive tax s%stem in place an! also a !esire to re!istribute rising incomes an! ealth so that the bene(its o( gro th can be more e>uitabl% share! out9 Evaluation0 What are the main constraints or limits on economic growth? )he 0S4 economy is no longer the biggest single dri+er of global demand 70@ of world economic growth in the ne,t few years will come from the emerging world 1he Importance of Infrastructure (Infrastructure systems E transport, electricity, telecommunications, water, etc E play a +ital role in economic and social de+elopment Increasingly interdependent, they are a means towards ensuring the deli+ery of goods and ser+ices that promote economic prosperity and growth, and contribute to *uality of life/ Source: <'52 Report, 200? ,n this section e outline some o( the possible constraints or limitations on the sustaine! gro th o( a countr%9 $ome o( these (actors appl% mainl% to !evelope! countries an! some are (ocuse! on the gro th potential o( lo er/income emerging economies man% o( hom have enEo%e! rapi! gro th in recent %ears9 Remember that economic gro th is a long/term concept re(erring in the main to a nation4s pro!uctive potential an! international competitiveness ' the (actors !iscusse! belo are some o( the !eman! an! suppl%/si!e issues that can hol! back potential output gro th (or a countr%9 What can limit the rate of economic growth? Infrastructure ' in(rastructure inclu!es capital such as ports5 transport net orks5 energ%5 po er an! ater supplies an! telecommunications net orks9 3oor in(rastructure hampers gro th because it causes higher costs an! !ela%s (or businesses5 re!uces the mobilit% o( labour an! hits the abilit% o( export businesses to get their pro!ucts to international markets9 A goo! example is ,n!ia hose (uture gro th is o(ten sai! to be threatene! b% structural eaknesses in her in(rastructure9 Man% countries ill nee! to increase their spen!ing on in(rastructure in the %ears ahea! to a!apt to an! !eal ith the conse>uences o( climate change9 #ependence on limited exports ' man% nations still rel%ing on specialising an! then exporting lo value a!!e! primar% commo!ities an! the prices o( these goo!s can be highl% volatile on orl!

markets9 When prices (all5 an econom% ill see a sharp re!uction in export incomes5 a higher tra!e !e(icit an! a gro ing risk that a nation ill not be able to (inance investment in e!ucation5 healthcare an! core in(rastructure9 Hver/specialisation can make a countr% vulnerable to the global economic c%cle9 +ulnerability to external shoc,s ' in to!a%4s global econom%5 events in one part o( the orl! can >uickl% have an e((ect in man% other countries9 *onsi!er the (all/out (rom the global (inancial crisis o( 2??B/2?@? hich brought about recession an! !eep (inancial !istress in man% regions9 (ccess to inance ('nsuring access to finance is essential for businesses to sur+i+e, in+est and grow Finance might come from banDs, pri+ate in+estors or capital marDets Garriers to accessing appropriate finance can pre+ent new companies from starting up and e,isting businesses from in+esting and growing/ Source: 0= )reasury Report 2ow national savings and low absolute savings ' savings are nee!e! to provi!e (inance (or investment9 ,n man% smaller lo /income countries5 high levels o( povert% make it almost impossible to generate su((icient savings to provi!e the (un!s nee!e! to (un! investment proEects9 #his increases reliance on international borro ing or tie! ai!9 2imited access to financial capital an! poorl% !evelope! !omestic capital markets ' this is particularl% the case (or man% small5 lo /income countries *orruption and poor governance ' this is a crucial (actor (or man% !eveloping countries9 Pigh levels o( !eepl% embe!!e! corruption an! bureaucratic !ela%s can harm gro th in man% a%s (or example inhibiting in ar! investment an! also making it more likel% that !omestic businesses ill invest overseas rather than at home9 -overnments nee! a stable an! e((ective legal (rame ork to collect taxes to pa% (or public services9 1ook at !e(icit an! !ebt problems (acing countries such as -reece9 ,n ,n!ia5 there are @C times more phone subscribers than taxpa%ers9 ,( a legal s%stem cannot protect private propert% rights then there ill be less research an! !evelopment F innovation9 #eclining and3or ageing population ' in some countries the actual size o( the population is !eclining partl% as a result o( net out ar! migration9 ,( a nation loses man% %ounger orkers this can have a !amaging e((ect on gro th9 #he changing age/structure o( a population also matters5 lea!ing (or example to a (all in the ratio o( orkers to !epen!ants9 "ising inflation ' (ast gro ing countries ma% experience an accelerating rate o( in(lation hich can have !amaging economic conse>uences ' these are covere! in the chapter on in(lation9 # o e((ects in particular can hit gro th5 namel% (alling real incomes an! pro(its together ith higher costs an! re!uce! competitiveness in international markets9 ,n our chart belo e track real -23 gro th an! in(lation rates in ,n!ia ' notice the steep rise in in(lation in recent %ears9 Man% other !eveloping countries have seen high rates o( in(lation in large part because o( booming (oo! an! other commo!it% prices9 -ustainability (4nyone who belie+es e,ponential growth can go on fore+er in a finite world is either a madman or an economist / =enneth Goulding, economist Persistent trade deficits due to rising imports ' $ome countries ma% experience large an! i!ening !e(icits on the current account o( their balance o( pa%ments9 #his means that the value o( importe! goo!s an! services is greater than the value o( exports an! net investment incomes lea!ing to an out(lo o( mone% (rom their econom%9 Pigh tra!e !e(icits might have to be covere! b% (oreign borro ing or a reliance on in(lo s o( capital investment (rom overseas multinationals9 An! large tra!e gaps can eventuall% lea! to a currenc% crisis an! possible loss o( investor con(i!ence9 4ver-extraction of the natural resource base ' natural resources provi!e an important source o(

ealth (or man% lo er/income countries an! hen orl! prices are high5 there is incentive to increase extraction rates to boost export earnings9 Po ever this might lea! to an excessive rate o( extraction that ultimatel% !amages the gro th potential o( an econom%9 2e(orestation an! rapi! extraction o( oceanic (ish stocks are t o goo! examples o( this9 Inade/uate investment in human capital ' to sustain gro th re>uires longer/term improvements in pro!uctivit%5 research F !evelopment an! innovation9 Whilst ph%sical capital such as (actories an! technolog% pla%s a role5 so too !oes the >ualit% o( the human input into pro!uction9 Economic gro th might be limite! b% skills shortages as businesses seek to expan! hich (orces up average ages an! labour costs9 Pigh level skills an! >uali(ications are also nee!e! to help businesses )an! ultimatel% countries0 to move up the value chain an! suppl% pro!ucts that can be sol! (or higher prices in the orl! econom%9 Wea,nesses in promoting and supporting entrepreneurship ' a thriving enterprise culture is crucial to encouraging ne business start/ups an! supporting them through the earl% gro th stage9 Economic and social costs from high levels of ine/uality of income and wealth ' this is an issue that has gro n in signi(icance over the %ears9 Although t o !eca!es or more o( globalisation has strengthene! average gro th rates in man% lo er an! mi!!le/income countries5 it has brought an increase in ine>ualities o( income an! ealth9 When the gap bet een rich an! poorer communities gets bigger there are man% possible !angers not least the costs o( social tension an! con(lict an! increasing spen!ing on insurance5 la an! or!er s%stems an! government el(are bills9 Excessive borrowing ' this (eature is common in (at/gro th phases (or richer !evelope! countries9 ,n particular e have seen in recent %ears a huge rise in personal sector borro ing an! !ebt5 much o( it linke! to eas% cre!it availabilit% an! rising propert% prices9 When a housing bubble bursts an! house prices (all5 man% thousan!s (in! themselves in !eep trouble9 Protectionism ' 3rotectionism is the use o( tari(( an! non/tari(( restrictions on imports to protect !omestic pro!ucers (rom (oreign competition9 #hese barriers to exporting restrict access to international markets an! !amage gro th (or nations ho have chosen an open approach to tra!e an! investment as a ke% path a% to expan!ing their economies9 *hina an! $outh 7orea have ha! export/ le! gro th !uring most o( their rapi!/gro th %ears9 ,n the ake o( the global (inancial crisis there have been i!esprea! (ears o( a return to protectionist tra!e policies9