Economic Growth and economic development

A country's economic health can usually be measured by looking at that country's economic growth and development.

A country's general economic health can be measured by looking at that country's economic growth and development. Let's take a separate look at what indicators comprise economic growth versus economic development. Economic growth is an important macro-economic objective because it enables increased living standards and helps create new jobs.

 Let's first examine economic growth. A country's economic growth is usually indicated by an increase in that country's gross domestic product, or GDP. Generally speaking, gross domestic product is an economic model that reflects the value of a country's output. In other words, a country's GDP is the total monetary value of the goods and services produced by that country over a specific period of time.

Example of Economic Growth

For example, let's say that a special berry grows naturally only in the country of Utopia. Natives to Utopia have used this berry for many years, but recently a wealthy German traveler discovered the berry and brought samples back to Germany. His German friends also loved the berry, so the traveler funded a large berry exporting business in Utopia. The new berry exporting business hired hundreds of Utopians to farm, harvest, wash, box and ship the berries to grocers in Germany.

In one calendar year, the berry exporting business added over one million dollars to Utopia's GDP because that's the total value of the goods and services produced by the new berry exporting business. Since Utopia's GDP increased, this means that Utopia experienced economic growth.

In the United States, our periods of large economic growth are mostly associated with new technology. The Industrial Revolution and the development of the Internet are two examples. When new developments bring an increase in output capacity, economic growth usually follows.

Economic Development

Now let's take a look at economic development. A country's economic development is usually indicated by an increase in citizens' quality of life. 'Quality of life' is often measured using the Human Development Index, which is an economic model that considers intrinsic personal factors not considered in economic growth, such as literacy rates, life expectancy and poverty rates.

While economic growth often leads to economic development, it's important to note that a country's GDP doesn't include intrinsic development factors, such as leisure time, environmental quality or freedom from oppression. Using the Human Development Index, factors like literacy rates and life expectancy generally imply a higher per capita income and therefore indicate economic development.

Example of Economic Development

For example, before the berry exporting business, most Utopians lived in small villages many miles from one another. Few Utopians had access to schools, fresh water or healthcare. Utopian men worked long hours attempting to farm land that was naturally unsuitable for most crops, just to feed their immediate families.

After the berry exporting business, many Utopians found work through the new industry. Newly employed villagers relocated closer to the business, giving them better access to schools, healthcare and fresh water produced for the plant and surrounding areas. Most Utopian men were able to trade labor-intensive hours in the fields for easier eight-hour shifts. Besides earning a salary, the new work enabled them more leisure time and contributed to longer life spans. Thus, Utopia experienced economic development.

Economic Growth

Economic growth means an increase in real GDP. This increase in real GDP means there is an increase in the value of national output / national expenditure.

Definitions

·         Balanced growth – growth that is sustainable (avoiding booms and busts)

·         Trade cycle – how economic growth can be cyclical – booms, busts, recovery.

·         Long run trend rate of growth – average sustainable growth rate over a period of time

Causes of economic growth

Economic growth is caused by two main factors

1.    Increase in aggregate demand (AD=C+I+G+X-M)

2.    Increase in aggregate supply (increase in capital, investment, higher labour productivity)

Economic growth in UK

Demand side causes

In the short term, economic growth is caused by an increase in aggregate demand (AD). If there is spare capacity in the economy then an increase in AD will cause a higher level of real GDP.

AD= C + I + G + X- M

·         C= Consumer spending

·         I = Investment (gross fixed capital investment)

·         G = Government spending

·         X = Exports

·         M = Imports

Graph showing increase in AD

AD can increase for the following reasons:

·         Lower interest rates – Lower interest rates reduce the cost of borrowing and so encourages spending and investment.

In 2008, base rates were cut to 0.5% to try and stimulate economic growth.

·         Increased wages. Higher real wages increase disposable income and encourages consumer spending.

·         Increased government spending (G). e.g. government investment on building new roads.

·         Fall in value of sterling which makes exports cheaper and increases quantity of exports(X).

·         Increased consumer confidence, which encourages spending (C).

·         Lower income tax which increases disposable income of consumers and increases consumer spending (C).

·         Rising house prices, which create a positive wealth effect and encourages homeowners to spend more.

2. Long term economic growth

This requires an increase in the long run aggregate supply (productive capacity) as well as AD.

potential growth can increase for the following reasons:

1.    Increased capital. e.g. investment in new factories or investment in infrastructure, such as roads and telephones.

2.    Increase in working population, e.g. through immigration, higher birth rate.

3.    Increase in labour productivity, through better education and training or improved technology.

4.    Discovering new raw materials.

5.    Technological improvements to improve the productivity of capital and labour e.g. Microcomputers and the internet have both contributed to increased economic growth.

Other factors affecting economic growth

·         Economic and political stability. Stability is important for reassuring firms it is a good idea to invest in increasing capacity. If we see a rise in uncertainty, confidence tends to fall and this can cause firms to delay investment.

·         Low inflation. Low inflation is a good climate for encouraging business investment. High inflation increases volatitlity.

In the 1980s, the UK achieved rapid rates of economic growth, this was caused by

·         Cuts in income tax, increasing disposable income

·         Boom in house prices, which caused a positive wealth effect

·         Rise in confidence, especially amongst south

·         Low real interest rates

The longest period of economic expansion on record was from 1992 – 2007. This period of economic growth was caused by

·         Low global inflation, which created period of economic stability.

·         Rise in house prices, which helped increase consumer spending.

·         Growth in productivity, helped by supply side reforms.

·         Inward investment helped create new jobs and better labour relations.

Policies to increase economic growth

1.    Supply Side Policies – government attempts to increase productivity and increase efficiency in the economy.

2.    Monetary policy – Reducing interest rates to stimulate economic activity and increase AD.

3.    Fiscal policy – Higher government spending and / or cutting taxes to boost aggregate demand

Benefits of economic growth

1.    Higher incomes

2.    Increased tax revenue for government which can be spent on public services, e.g. education and health care

3.    Helps create employment

1.    Higher average incomes. This enables consumers to enjoy more goods and services and enjoy better standards of living.

2.    Lower unemployment With higher output and positive economic growth firms tend to employ more workers creating more employment.

UK unemployment rises during a recession – falls during periods of economic growth.

3.    Lower government borrowing. Economic growth creates higher tax revenues and there is less need to spend money on benefits such as unemployment benefit. Therefore economic growth helps to reduce government borrowing. Economic growth also plays a role in reducing debt to GDP ratios.Long period of economic growth in the post-war period helped reduce debt to GDP ratio.

4.    Improved public services. With increased tax revenues the government can spend more on public services, such as the NHS and education e.t.c.

5.    Money can be spent on protecting the environment. With higher real GDP a society can devote more resources to promoting recycling and the use of renewable resources

6.    Investment. Economic growth encourages investment and therefore encourages a virtuous cycle of economic growth.

 Potential costs of economic growth

1.    Inflation. If growth is too fast, we could experience inflation.

2.    Current account deficit. If growth is unbalanced, we could see a growing current account deficit.

3.    Environmental costs. Economic growth leads to higher resource consumption and pollution.

Costs of economic growth

Despite the benefits of economic growth, there are also potential costs, such as inflation, a current account deficit, environment costs and widening inequality.

However, the costs of economic growth will depend on the type of growth that we see.

Potential costs of economic growth include:

1. Inflation. If AD increases faster than AS then economic growth will be unsustainable. Economic growth tends to cause inflation when the growth rate is above the long run trend rate of growth. It is when demand increases too quickly that we get a positive output gap and firms push up prices.

2. Boom and bust economic cycles. If economic growth is unsustainable then high inflationary growth may be followed by a recession. This occurred in the UK in the late 1980s and early 1990s.

In the 1980s there was an economic boom with growth of over 5% a year. However this caused inflation to rise to over 10%. To reduce inflation the government increased interest rates, this caused the economy to slow down and then enter into a recession.

·         However if economic growth is at a sustainable rate this will not occur. For example, between 1993 and 2007, both economic growth and inflation were at a sustainable rate.

3. Current account deficit
Increased economic growth tends to cause an increase in spending on imports therefore causing a deficit on the current account.

This shows that in the  UK 1980s boom, there was an increasing deficit in the balance of goods and services. In the recession of 1991, there was an improvement in the current account. The UK is susceptible to a current account deficit during high growth because we have a high marginal propensity to import.

4. Environmental costs
Increased economic growth will lead to increased output and therefore increased pollution and congestion. This will cause health problems such as asthma and therefore will reduce the quality of life. Economic growth also means greater use of raw materials and can speed up depletion of non-renewable resources.

5. Inequality
Higher rates of economic growth have often resulted increased inequality because growth can benefit a small section of society more than others. For example, those with assets and wealth will see a proportionally bigger rise in the market value of rents and their wealth. Those unskilled without wealth may benefit much less from growth.

However it depends upon things such as tax rates and the nature of economic growth. Economic growth can also be a force for reducing absolute and relative poverty.

Evaluation

It depends on the nature of economic growth. If growth is balanced and sustainable then it can occur without inflation. Also the environmental costs of economic growth can be minimised through better use of technology.

The average sustainable rate of growth over a period of time

Recessions

A period of negative economic growth, where output falls for two consecutive quarters.

·         The Great Depression 1929-1939

·         Recessions

·         Causes of Recessions

·         Recession 1980-81

·         Recession 1991-92

·         Great recession 2008-13