What Is Economic Growth and Why It’s Important
Economic indicators, akin to a thermometer, provide valuable insights into the state of a country’s economy. Among these indicators, the economic growth rate holds particular significance, serving as a barometer of progress and prosperity within a nation. Just as growth in any sphere signifies maturation, when it’s applied to the economy, it denotes a society’s commitment to substantial advancement. Economic growth, at its core, signifies an increase in the production of economic goods and services within a specific timeframe compared to a preceding period.
The concept of economic growth isn’t confined to a single definition; it can be adapted and measured nominally or in real terms, factoring in the inflation rate. In this article, we delve into the intricacies of the economic growth rate and explore the factors that influence it.
Understanding Economic Growth
Economic growth, in essence, refers to the expansion of economic goods and services production from one time period to another. Typically, the overall economic growth of a nation is quantified using metrics like Gross National Product (GNP) or Gross Domestic Product (GDP), although alternative measurements are sometimes employed.
Economic growth is synonymous with the augmentation of goods and services produced within an economy. This surge can be attributed to increased capital goods, labor force, technological advancements, and human capital development. Economists often measure economic growth by assessing the increase in the total market value of additional goods and services, approximated through metrics such as GDP.
According to a decade-long study conducted by the United Nations University’s Global Institute for Development Economics Research (UNITAR), countries that have effectively reduced poverty and expanded access to public resources have achieved these milestones by fostering robust economic growth. However, it’s crucial to note that for growth to be sustainable, its benefits must extend beyond an exclusive elite group.
Why Is Economic Growth Important?
Economic growth stands as one of the most critical benchmarks of a thriving economy. Long-term growth in a country yields substantial benefits, most notably a positive impact on national income and employment levels, resulting in an elevated standard of living. The nexus between production growth and employment lies at the core of this phenomenon, leading to the enrichment of a nation and its populace.
Moreover, higher economic growth generates additional tax revenue for government expenditure. These funds can be leveraged by the government to further develop the economy or to address budget deficits effectively.
Six Factors of Economic Growth
Economic growth is influenced by various factors, some of which are outlined below.
1. Natural Resources: The discovery of additional natural resources, such as oil or mineral deposits, can contribute to economic growth by expanding a country’s production possibilities. These resources encompass not only minerals but also agricultural land, water, forests, natural gas, and more.
2. Capital and Physical Infrastructure: Increased investment in physical capital, including factories, machinery, and infrastructure like roads, reduces the cost of economic activities. This boost in productivity results in more efficient production. For instance, a well-developed highway system minimizes inefficiencies in the transportation of raw materials and goods across a country, leading to increased GDP.
3. Population or Workforce: A growing population translates to a larger pool of available workers, equating to a more extensive labor force. However, it’s essential to note that a large population can also bring about challenges, such as higher unemployment rates.
4. Human Capital: Investing in human capital enhances the quality of the workforce. This investment encompasses improved skills, abilities, and training, ultimately leading to a more skilled and productive workforce. Skilled workers are known for their higher productivity, which significantly impacts economic growth.
5. Technological Advancements: Technological progress is a pivotal factor in economic growth. Technology enhances productivity and efficiency, allowing for increased output with the same amount of work. It results in lower production costs, thus fostering consistent long-term growth.
6. Legal Framework: The presence of supportive laws favoring producers and removing obstacles, such as those related to taxation, can play a significant role in fostering economic growth.
Limiting Factors of Economic Growth
While economic growth is a desirable goal, various factors can limit this process. Some of these limiting factors include:
1. Low Level of Healthcare Services: Inadequate access to healthcare services can result in lower productivity among a population. This lack of access prevents the full utilization of the available workforce’s potential.
2. Lack of Necessary Infrastructure: Many developing countries grapple with insufficient infrastructure, such as roads, schools, and hospitals. This deficit in infrastructure elevates transportation costs and reduces overall economic efficiency within the country.
3. Capital Flight: When a country fails to offer the expected returns to investors, they may withdraw their investments in pursuit of higher returns elsewhere. This capital flight can have detrimental effects on the nation’s economic growth.
4. Political Instability: Political instability in government can deter investors and hinder investment. Historical examples, such as Zimbabwe’s political uncertainty and the absence of property protection laws, have discouraged many investors who seek more reliable and stable returns.
5. Institutional Framework: Inadequate legal frameworks that fail to adequately protect the rights of producers can significantly impede development and investment.
The Economic Miracle of Japan and Germany
Germany and Japan are remarkable success stories in terms of economic growth. Despite their current status as economic superpowers, it’s essential to recognize that in 1946, both of these nations were grappling with severely damaged economies, largely due to the devastation caused by World War II.
In 1946, the per capita production rate in both countries had dwindled to half of its pre-war levels. However, over the ensuing decades, both nations would go on to experience some of the most remarkable economic growth in recorded history.
Between 1946 and 1972, Japan witnessed per capita growth at an impressive rate of 8.0 percent per year, while Germany’s growth stood at 6.5 percent per year. By comparison, the United States recorded a growth rate of 2.1 percent during the same period. It’s worth noting that various European countries also experienced significant economic growth in the post-war era.
For example, France saw a 4.6 percent annual growth in output per labor force, and Italy achieved a growth rate of 5.5 percent per year. However, it was Japan and Germany, two nations severely affected by World War II, that emerged as leaders in post-war economic growth.
Theories of Economic Growth
Numerous growth theories and models have been developed over time, with some of the most influential ones discussed below.
1. Classical Economic Growth Theory:
Early economic theories and models, largely developed in Britain during the Industrial Revolution, were championed by economists such as Adam Smith and David Ricardo. These theories sought to identify the factors driving a nation’s economic growth. Productive investment was deemed the most critical means of achieving growth. However, sustainable economic growth also depended on factors like reinvesting profits into production, fostering free trade, private ownership, competitive markets, and the division of labor. The introduction of comparative advantage further accelerated the growth of Western countries.
2. Solow-Swan Economic Growth Theory:
The Solow-Swan growth model, developed in the mid-20th century by Robert Solow and Trevor Swan, remains a crucial economic growth model. It places emphasis on capital accumulation, labor productivity, and technological advancement as primary drivers of economic growth.
Notably, this model underscores that changes in a country’s technology level have a greater impact than prior models. Two fundamental assumptions underlie this model: efficient capital use and diminishing returns for increasing capital and labor.
Predictions derived from these assumptions include higher growth from equal investment in poorer countries, as they experience greater returns on capital, and the idea that capital growth alone will eventually cease to drive economic growth, highlighting the significance of technological advancement.
Benefits of Economic Growth
Economic expansion, or growth, brings forth a range of advantages:
1. Higher Income: Government initiatives geared toward boosting economic development result in elevated income levels. Increased income enables individuals to afford a wider array of products and services, thereby enhancing their quality of life.
2. Poverty Reduction: Economic growth has a direct impact on poverty reduction. As more people secure employment and find sustainable means of supporting themselves, they can lift themselves out of poverty, ultimately leading to more fulfilling lives.
3. Better Facilities: As employment rates rise and income levels increase, individuals within an economy gain access to improved educational opportunities and skills development. This, in turn, positions them to capitalize on the right job opportunities, fostering personal and professional growth.
4. Enhanced Quality of Life: Enhancements in various aspects of life automatically translate to an improved quality of life. Economic growth paves the way for individuals and communities to access better healthcare, education, and overall living conditions.
An Overview of the Trend in Global Economic Growth
Over the past century, the world economy has witnessed remarkable growth. According to data from the World Bank, using the base year of 2015, the global gross product expanded from approximately $10.9 trillion in 1960 to about $48.3 trillion in 2000. As time progressed and innovation proliferated, alongside the widespread adoption of new technologies, such as the Internet, this figure surged to $82 trillion by the year 2020. This represents an impressive growth rate of approximately 3.6 percent.
Economic Growth of the United States, China, and India
The United States, as the world’s leading economy, has demonstrated impressive economic growth since World War II. According to statistics from the United States Economic Affairs Organization, from 1947 to 2021, the American economy has experienced an average annual growth rate of 3.2 percent.
Notably, alongside established economies, emerging nations like China have witnessed remarkable expansion during this period. As a result, China now ranks as the world’s second-largest economy. These countries often experience even more significant growth, thanks to the presence of untapped investment opportunities. For instance, China achieved an average annual economic growth rate of 9.5 percent between 1981 and 2020. India, another rapidly developing nation, has attracted investments from developed countries and established a strong foothold in the information technology sector, registering an average annual growth rate of 6.9 percent between 1960 and 2020.
