Discuss the Causes and Effects of Economic Growth

Economic growth is the overall growth in an economy. Gross National Product and Gross Domestic Product are the normal measures of economic growth. Because growth can come in many ways, GNP and GDP are not particularly good measures. More so, economic growth can occur from having more people in an economy. If economic growth occurs more slowly than the population growth, then there can be economic growth, but the average person is less well-off. As economic growth is measured as the annual percent change of National Income it has all the advantages and drawbacks of that level variable.

There are two types of economic growth, ACTUAL and POTENTIAL. We have to recognise the difference between actual and potential economic growth.

Actual Growth: this is the percentage annual increase in national output and is also known as the ‘GDP’ (Gross Domestic Output). This is said to be the rate of growth in actual output produced. Statistics of GDP growth rates refer to actual growth when they are published.

This is a table of the GDP Growth rates for the last 10 years. I have included a few countries including the UK:

Year U.K. Italy Netherlands Belgium Switzerland Sweden Australia New Zealand
2005 - 0.16 0.94 1.16 - 2.47 2.46 -
2004 3.08 1.22 1.72 2.59 2.07 3.74 3.55 3.48
2003 2.20 0.25 -0.13 0.91 -0.27 1.69 3.07 3.88
2002 1.77 0.38 0.08 1.50 0.31 2.00 4.13 4.46
2001 2.30 1.76 23.31 1.05 1.04 1.07 2.24 3.78
2000 3.86 3.58 3.47 3.86 3.61 4.33 3.33 2.48
1999 2.80 1.65 5.27 10.39 1.31 -1.04 4.32 5.16
1998 3.12 1.81 3.09 2.08 2.79 3.65 5.30 1.00
1997 3.29 2.03 3.83 3.88 1.91 2.44 3.86 2.74
1996 2.69 1.09 3.05 0.85 0.52 1.29 4.32 3.23
1995 2.84 2.92 3.03 2.29 0.38 4.05 3.49 3.74
Source: http://investintaiwan.nat.gov.tw/en/env/stats/gdp_growth.html

Potential Growth: This is how quickly the economy could grow. It is known as the percentage annual increase in the economies capacity to produce.

Major factors that can contribute to potential economic growth include:-

 An increase in resources – natural, labour or capital.
 Increase in the potential with which these resources can be used, through advances in technology, enhanced labour skills or bettered organisation.

Actual growth will tend to rise and fall. In some years there can be a high rate of growth; this is when the country will experience what is known as a ‘boom’. In other years quite simply growth is low or negative; this is when the country is in recession a period of ‘slump’ or ‘depression’. This series of booms and recessions is commonly known as the business cycle.

There are four ‘phases’ of the business cycle:

1. The upturn – During this phase, a contracting or inactive economy starts to improve, and growth in actual output resumes.
2. The expansion – In this stage there is rapid economic growth: the economy is booming. An extensive use is made of resources and the bridge between actual and potential output narrows.
3. The peaking out – Throughout this phase, growth slows down and can even end.
4. The slowdown, recession or slump – In this period, there is little or no growth and even a decline in output.

Causes of growth

Economic growth is caused first and foremost by factors on the supply part of the economy, factors such as increases in both the quantity of and in the productivity of the economic resources accessible to the economy. These economic resources include land and natural resources, labour (measured in man-hours of work), capital (man-made productive resources).

Increases in the quantity of economic resources may include the development of land for economic use, the unearthing and exploitation of new natural resources, increases in the working population, but the most significant contributor is increases in the stock of capital goods, which is known as capital accumulation. Economists call the production of new capital goods investment, and the rate of investment is an important determinant of the rate of economic growth.

Since Economic Growth is caused by enhancement in the quantity and quality of the factors of production that a country has accessible i.e. land, labour, capital and enterprise.

Improving the Quantity and Quality of Land Resources
Increases in the amount of land available for agriculture will boost economic growth. All economic resources are in short supply and have an opportunity cost. The comparative shortage of land in the face of a rising population means that the law of declining returns might also become significant. The law predicts that an escalating amount of labour applied to a fixed quantity of land the marginal productivity of the labour will fall.
Improving the Quantity and Quality of Human Resources
A rise in the supply of labour can increase economic growth. Increases in the population can increase the amount of young people entering the labour force. Increases in the population can also lead to a boost in market demand thus motivating production. However, if the population grows at a quicker rate than the level of GDP the GDP per capita will drop.
Causes of fluctuations in actual growth

A vast rise in aggregate demand will create shortages. This will have a tendency to encourage firms to increase output consequently reducing slack in the economy. Also, a reduction in aggregate demand will leave firms with increased stocks of unsold goods. This therefore makes them inclined to reduce output.
A boom is affiliated with a rapid rise in aggregate demand; the faster the rise in aggregate demand, the higher the short run rate of actual growth. A recession as I explained earlier in comparison is associated with a decline in aggregate demand.

In the long run, there are two determinants of actual growth:

 The growth in aggregate demand. This determines whether potential output will be realised.
 The growth in potential output.

Causes of potential growth

This concerns the question of supply. It is concerned with the capacity of the economy to produce. Potential output has two main determinants:

 The amount of resources available
 Their productivity

Capital – The nations output is dependant on its stock of capital. Output increases with increase in this stock. If society worries about the problem of machines becoming outdated and needing replacing, then the stock of capital will increase by the amount of investment. The increase in output that causes this will depend on the productivity of capital.

Government policy can help the economy grow, two policies are the fiscal policy and monetary policy these can influence the level of demand. If you find that the economy is growing too slowly then you can try to boost demand; to do this spending needs to be encouraged and so either taxes or interest rates need to be cut. These policies are all called reflationary policies.

However, the Government would have to be careful. They would have to watch mostly the level of inflation, because if demand rises too much, as a result of extra spending firms may not be able to increase production quickly enough and prices may rise instead of output. If this happens, you may need to use the opposite deflationary policies. This would result in taxes and interest rates getting increasing.

Benefits of economic growth

Government Policies and Economic Growth
 Open markets - internal and external competition in markets for goods and services
 Promotion of free-thinking capital market providing a flow of liquidity to finance investment
 Protection of private property rights
 Scale of government spending - possible crowding out of the private sector if government spending is too
 Efficiency of the tax and benefit system - may create disincentives which constrains the active labour supply
 Macro-economic stability and credibility of macro economic policy