10.1 Definition of Economic growth
is the increase of per capita gross domestic product (GDP) or other measure of aggregate income. It is often measured as the rate of change in real GDP. Economic growth refers only to the quantity of goods and services produced. An industrial economy gets its resource from other countries.
Economic growth can be either positive or negative. Negative growth can be referred to by saying that the economy is shrinking. Negative growth is associated with economic recession and economic depression. In order to compare per capita income among countries, the statistics may be quoted in a single currency, based on either prevailing exchange rates or purchasing power parity. To compensate for changes in the value of money (inflation or deflation) the GDP or GNP is usually given in “real” or inflation adjusted, terms rather than the actual money figure compiled in a given year, which is called the nominal or current figure.
Economists draw a distinction between short-term economic stabilization and long-term economic growth. The topic of economic growth is primarily concerned with the long run. The short-run variation of economic growth is termed the business cycle. The long-run path of economic growth is one of the central questions of economics; despite some problems of measurement, an increase in GDP of a country is generally taken as an increase in the standard of living of its inhabitants. Over long periods of time, even small rates of
annual growth can have large effects through compounding (see exponential growth). A growth rate of 2.5% per annum will lead to a doubling of GDP within 29 years, whilst a growth rate of 8% per annum (experienced by some Four Asian Tigers) will lead to a doubling of GDP within 10 years. This exponential characteristic can exacerbate differences across nations.
10.2 Theories of Economic Growth
Classical growth theory
The modern conception of economic growth began with the critique of Mercantilism, especially by the physiocrats and with the Scottish Enlightenment thinkers such as David Hume and Adam Smith, and the foundation of the discipline of modern political economy. The theory of the physiocrats was that productive capacity, itself, allowed for growth, and the improving and increasing capital to allow that capacity was “the wealth of nations”. Whereas they stressed the importance of agriculture and saw urban industry as “sterile”, Smith extended the notion that manufacturing was central to the entire economy
David Ricardo argued that trade was a benefit to a country, because if one could buy a good more cheaply from abroad, it meant that there was more profitable work to be done here. This theory of “comparative advantage” would be the central basis for arguments in favor of free trade as an essential component of growth.
Creative destruction and economic growth
Many economists view entrepreneurship as having a major influence on a society’s rate of technological progress and thus economic growth. Joseph Schumpeter was a key figure in understanding the influence of entrepreneurs on technological progress. In Schumpeter’s Capitalism, Socialism and Democracy, published in 1942, an entrepreneur is a person who is willing and able to convert a new idea or invention into a successful innovation. Entrepreneurship forces “creative destruction” across markets and industries, simultaneously creating new products and business models. In this way, creative destruction is largely responsible for the dynamism of industries and long-run economic growth. Former Federal Reserve chairman Alan Greenspan has described the influence of creative destruction on economic growth as follows: “Capitalism expands wealth primarily through creative destruction—the process by which the cash flow from obsolescent, low-return capital is invested in high-return, cutting-edge technologies.”
The neoclassical growth model/Solow-Swan Growth Model
The notion of growth as increased stocks of capital goods (means of production) was codified as the Solow-Swan Growth Model, which involved a series of equations which showed the relationship between labor-time, capital goods, output, and investment. According to this view, the role of technological change became crucial, even more important than the accumulation of capital. This model, developed by Robert Solow and Trevor Swan in the 1950s, was the first attempt to model long-run growth analytically. This model assumes that countries use their resources efficiently and that there are diminishing returns to capital and labor increases. From
these two premises, the neoclassical model makes three important predictions. First, increasing capital relative to labor creates economic growth, since people can be more productive given more capital. Second, poor countries with less capital per person will grow faster because each investment in capital will produce a higher return than rich countries with ample capital. Third,
because of diminishing returns to capital, economies will eventually reach a point at which no new increase in capital will create economic growth. This point is called a “steady state”.
The model also notes that countries can overcome this steady state and continue growing by inventing new technology. In the long run, output per capita depends on the rate of saving, but the rate of output growth should be equal for any saving rate. In this model, the process by which countries continue growing despite the diminishing returns is “exogenous” and represents the creation of new technology that allows production with fewer resources. Technology improves, the steady state level of capital increases, and the country invests and grows. The data does not support some of this model’s predictions, in particular, that all countries grow at the same rate in the long run, or that poorer countries should grow faster until they reach their steady state. Also, the data suggests the world has slowly increased its rate of growth. However modern economic research shows that the baseline version of the neoclassical model of economic growth is not supported by the evidence.
Endogenous growth theory
Growth theory advanced again with the theories of economist Paul Romer and Robert Lucas, Jr. in the late 1980s and early 1990s.
Unsatisfied with Solow’s explanation, economists worked to “endogenize” technology in the 1980s. They developed the endogenous growth theory that includes a mathematical explanation of technological advancement. This model also incorporated a new concept of human capital, the skills and knowledge that make workers productive. Unlike physical capital, human capital has increasing rates of return. Therefore, overall there are constant returns to capital, and economies never reach a steady state. Growth does not slow as capital accumulates, but the rate of growth depends on the types of capital a country invests in. Research done in this area has focused on what increases human capital (e.g. education) or technological change (e.g. innovation)
10.3 Effects of Economic Growth
10.3.1 Positive effects
Economist argues that global income inequality is diminishing, and the World Bank argues that the rapid reduction in global poverty is in large part due to economic growth. The decline in poverty has been the slowest where growth performance has been the worst (i.e. in Africa).
Quality of life
Happiness has been shown to increase with a higher GDP per capita, at least up to a level of $15,000 per person.
10.3.2 Negative effects of economic growth
A number of critical arguments have been raised against economic growth.
Growth ‘to a point’
It may be that economic growth improves the quality of life up to a point, after which it doesn’t improve the quality of life, but rather obstructs sustainable living. Historically, sustained growth has reached its limits (and turned to catastrophic decline) when perturbations to the environmental system last long enough to destabilize the bases of a culture
Growth may lead to consumerism by encouraging the creation of what some regard as artificial needs: Industries cause consumers to develop new taste, and preferences for growth to occur. Consequently, “wants are created, and consumers have become the servants, instead of the masters, of the economy.”
Many earlier predictions of resource depletion, such as Thomas Malthus’ 1798 predictions about approaching famines in Europe, The Population Bomb (1968) Limits to Growth (1972), and the Simon–Ehrlich wager (1980) did not materialize, nor has diminished production of most resources occurred so far, one reason being that advancements in technology and science have allowed some previously unavailable resources to be produced. In the case of the limited resource of land, famine was relieved firstly by the revolution in transportation caused by railroads and steam ships, and later by the Green Revolution and chemical fertilizers, especially
the Haber process for ammonia sythesis In the case of minerals, lower grades of mineral resources are being extracted, requiring higher inputs of capital and energy for both extraction and processing An example is natural gas from shale and other low permeability rock, which can be developed with much higher inputs of energy, capital and materials than conventional gas in previous decades. Another example is offshore oil and gas, which has exponentially increasing cost as water depth increases.
Also, physical limits may be very large if considering all the minerals in the planet Earth or all possible resources from space colonization, such as solar power satellites, asteroid mining, or a Dyson sphere. The book Mining the Sky: Untold Riches from the Asteroids, Comets, and Planets provides an alternative example of such arguments. However, critics these proposals have no realistic plan of implementation and would suffer from prohibitively high energy and capital cost.
Depletion and declining production from old resources can occur before replacement resources are developed. This is, in part, the logical basis of the Peak Oil theory, about which recent discussion on www.theoildrum.com raises the possibility that peak oil may have already occurred.
The 2007 United Nations GEO-4 report states that humans are living beyond their means. Humanity‘s environmental demand is purported to be 21.9 hectares per person while the Earth‘s biological capacity is purported to be 15.7 ha/person. This report reinstates the basic arguments and observations made by Thomas Malthus in the early 19th century Economic inequality has increased; the gap between the poorest and richest countries in the world has been growing. Some critics argue that a narrow view of economic growth, combined with globalization, is creating a scenario where we could see a systemic collapse of our planet’s natural resources.
Other critics draw on archaeology to cite examples of cultures they claim have disappeared because they grew beyond the ability of their ecosystems to support them Concerns about possible negative effects of growth on the environment and society led some to advocate lower levels of growth, from which comes the ideas of uneconomic growth and de-growth, and Green parties which argue that economies are part of a global society and a global ecology and cannot outstrip their natural growth without damaging them.
Those more optimistic about the environmental impacts of growth believe that, although localized environmental effects may occur, large scale ecological effects are minor. The argument as stated by commentators Julian Lincoln Simon states that if these global-scale
ecological effects exist, human ingenuity will find ways of adapting to them.
While acknowledging the central role economic growth can potentially play in human development, poverty reduction and the achievement of the Millennium Development Goals, it is becoming widely understood amongst the development community that special efforts must be made to ensure poorer sections of society are able to participate in economic growth.