Economic Growth Notes
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 of Economic Growth
Income distribution
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
Consumerism
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.”
Resource depletion
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.
Environmental impact
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.
Equitable growth
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.
