Economic growth

Economic Growth: The Engine of Prosperity

Imagine the economy as a living organism, growing and evolving over time. Economic growth is that vital process that propels this organism forward, making it stronger and more resilient. It’s the increase or improvement in inflation-adjusted economic output over time, measured by real Gross Domestic Product (GDP) growth rate, real GDP per capita growth rate, or GNI per capita growth.

Types of Economic Growth

There are two primary types of economic growth: intensive and extensive. Intensive growth is like squeezing more juice from an orange—using the same inputs but making them work more efficiently. Extensive growth, on the other hand, is akin to planting a new tree in your garden—increasing the number of inputs available.

Innovation as the Spark

But what truly ignites this growth? Innovation! Think of it like the spark that sets off a chain reaction. It can be technological advancements, new business models, or even changes in social norms. These innovations drive productivity increases, which lower the real cost of goods and lead to rising living standards.

Measuring Economic Growth

Economists use national income accounting to measure per capita output, considering factors such as labor productivity, hours worked, participation rate, and demographics. The rate of change in GDP per population is essentially the sum of these rates plus their cross products. This gives us a comprehensive picture of how an economy is performing over time.

Long-Run vs Short-Run Growth

Long-run economic growth focuses on structural causes, while short-run variation is termed the business cycle. Historically, productivity increases have been the most important source of real per capita economic growth, accounting for 80% of the rise in U.S. per capita income.

The Drivers of Economic Growth

Economic growth has traditionally been attributed to several key factors: the accumulation of human and physical capital, increases in productivity, technological innovation, and division of labor. Increases in productivity are the major factor responsible for per capita economic growth since the mid-19th century.

Historical Examples

During the Industrial Revolution, mechanization replaced hand methods in manufacturing, and machine tools enabled interchangeable parts. The Second Industrial Revolution saw a substitution of inanimate power for human labor, driving productivity growth. Other major sources included automation, transportation infrastructures, new materials, and scientific agriculture.

Human Capital: The Fuel

Human capital is crucial to economic growth, representing the skills of the population or workforce. It’s difficult to measure due to its creation at home, school, and on the job. Economists use numerous proxies, including literacy levels, numeracy, book production, average formal schooling, and test scores.

Modern Perspectives

The most commonly-used measure of human capital is the level of school attainment in a country. However, this measure has limitations, such as not accounting for human capital development outside of formal schooling. Theoretically, human capital represents economic growth, particularly in log-linear models.

Political Institutions and Economic Growth

Political institutions play a significant role in shaping behavior and incentives, affecting a nation’s success or failure. The adoption of government policies that foster commerce and give individuals personal and economic freedom contributed to economic growth in the British state after the Glorious Revolution of 1688.

Inequality and Economic Growth

The relationship between inequality and economic growth is complex. While some argue that inequality stimulates capital accumulation and economic growth, others suggest it has an adverse effect on human capital formation, income per capita, and the growth process. Theories by Galor and Zeira argue that inequality has an enduring impact on human capital formation and economic growth.

Challenges to Continuous Growth

While economic growth has been a driving force for prosperity, it also poses challenges. The Malthusian theory suggests population growth exceeds food supply resource growth, leading to reduced living standards and even population die-off in some cases. Classical growth theory proposes production and growth based on sustainability and variable proportions.

The Solow-Swan Model

The Solow–Swan model describes economic growth through virtuous cycles and technological progress, with the latter assuming diminishing returns to capital and labor, steady state conditions, and conditional convergence among countries. However, the model’s limitations include its inability to explain determinants of investment rates.

Endogenous Growth Theory

In response to these challenges, economists have developed endogenous growth theory that incorporates human capital and technological advancement. This model emphasizes broad-based effects of human capital investment, which can be realized by other firms in the economy. The basic model implicitly predicts convergence but is flawed because it assumes financial capital flows to countries with higher returns.

Environmental Concerns

The large impact of a relatively small growth rate over a long period of time is due to the power of exponential growth. However, as we’ve seen in recent years, this growth comes at an environmental cost. The 2019 Global Assessment Report warned that society should not focus solely on economic growth due to substantial loss of biodiversity.

Alternative Economic Systems

Academia has developed concepts like uneconomic growth, steady-state economy, and eco-socialism to achieve a more sustainable future. Politics has seen green parties embracing the Global Greens Charter, recognizing that excessive use of natural resources is causing environmental deterioration.

The Future of Economic Growth

While economic growth has been central to government policy, it’s becoming widely understood that special efforts must be made to ensure poorer sections of society are able to participate in this growth. The effect of economic growth on poverty reduction – the growth elasticity of poverty – can depend on the existing level of inequality.

The Role of Technology

Technological advancements have been crucial in driving economic growth, but they also pose challenges. Some physical scientists believe that continuous economic growth is unsustainable due to finite resources and increasing costs. The Limits to Growth study modeled limitations to infinite growth in 1972.

Conclusion

Economic growth is the part of macroeconomics that really matters, but it must be balanced with environmental sustainability. As we move forward, we need to find ways to ensure that economic growth benefits all segments of society while preserving our planet’s resources for future generations. The journey towards a sustainable and equitable economy is ongoing, and every step counts.