What Is Economic Growth and How Is It Measured? – UPSC Notes – Economy
Economic Growth pertains to the escalation in a nation’s income or output of goods and products compared to a preceding period. Conversely, economic development entails sustained, long-term growth, and augmented income for a country. Developed countries or economies can tackle issues like healthcare and gender equality. While economic growth denotes the continuous increase in a country’s real national and per capita income, economic development is characterized by the continual enhancement of the material well-being of society. It’s imperative to recognize that economic development encompasses a broader scope than economic growth.
What Is Economic Growth?
Economic growth is the expansion of production of economic goods and services over time, compared to a prior period. This growth can be assessed in nominal or real (adjusted for inflation) terms. Typically, aggregate economic growth is gauged through gross national product (GNP) or gross domestic product (GDP), although other measures may also be employed.
Key Takeaways
- Economic growth: Rise in production of goods and services within an economy.
- Factors contributing to growth: Increase in capital goods, labor force, technology, and human capital.
- Measurement: Typically assessed through aggregated market value of additional goods and services, often using Gross Domestic Product (GDP) estimates.
- Phases of economic growth: Expansion, peak, contraction, and trough.
- Effectiveness of tax cuts: Generally less effective in stimulating economic growth compared to increases in government spending.
- Sustainability of growth: If benefits are concentrated among a select group, the growth is unlikely to be sustainable.
Understanding Economic Growth
In its simplest form, economic growth denotes a surge in aggregate production within an economy, often resulting in a boost in national income. This upswing typically corresponds with a rise in average marginal productivity, prompting higher incomes. Consequently, consumers tend to increase spending, elevating both material quality of life and standard of living.
In economics, growth is commonly depicted as a function of physical capital, human capital, labor force, and technology. In essence, augmenting the quantity or quality of the workforce, their tools, and the methods for combining labor, capital, and raw materials leads to heightened economic output.
Phases of Economic Growth
The business cycle characterizes the varying stages of economic activity within an economy. It comprises four distinct phases:
- Expansion – Marked by increases in employment, income, industrial production, and sales, alongside a rising real GDP.
- Peak – Represents the zenith of an economic expansion, serving as a pivotal turning point.
- Contraction – Witnessed as the elements of expansion begin to decline, potentially leading to a recession if there is a substantial downturn in economic activity across the economy.
- Trough – Marks the lowest point of an economic contraction, representing its nadir.
A single business cycle is defined from peak to peak or trough to trough. These cycles typically lack regularity in duration, sometimes featuring periods of contraction within an expansion and vice versa.
Since World War II, the U.S. economy has witnessed more expansions than contractions. From 1945 to 2019, the average expansion spanned approximately 65 months, whereas the average contraction was merely 11 months. However, the Great Recession, lasting 18 months from December 2007 to June 2009, disrupted this pattern. It was succeeded by the longest expansion on record, spanning 128 months until 2020 and the onset of the COVID-19 pandemic.
Important Facts
Governments frequently aim to stimulate economic growth by reducing interest rates, effectively making money cheaper to borrow. However, this strategy has its limits. Eventually, as witnessed in 2022, interest rates must be increased to address price inflation and prevent the economy from overheating.
How To Measure Economic Growth
The most common gauge of economic growth is real GDP. This represents the total value of all goods and services produced within an economy, adjusted to remove inflationary effects. There are three primary methods for assessing real GDP:
- Quarterly growth at an annual rate: This method examines the change in GDP from one quarter to the next, then compounds it into an annual rate. For instance, if a quarter’s change is 0.3%, the annual rate would be extrapolated to 1.2%.
- Four-quarter or year-over-year growth rate: This approach compares the GDP of a single quarter from two consecutive years as a percentage. It’s commonly used by businesses to account for seasonal variations.
- Annual average growth rate: This calculates the average of changes in GDP over the four quarters. For example, if four-quarter rates for 2022 were 2%, 3%, 1.5%, and 1%, the annual average growth rate would be (7.5% ÷ 4) = 1.875%.
Tip
GDP, the preeminent metric for gauging economic growth, is computed by summing up all the expenditures made by consumers, businesses, and the government within a specified timeframe. The formula is as follows:
GDP = consumer spending + business investment + government spending + net exports
Measuring the value of a commodity poses challenges. Goods and services are not universally valued the same, as some hold more significance than others. For instance, a smartphone is deemed more valuable than a pair of socks. Hence, growth must be assessed based on the value of goods and services, not merely their quantity.
Another complication arises from individual preferences. The worth of goods and services varies among individuals; for instance, a heater holds more value for a resident of Alaska, while an air conditioner is more valuable for a resident of Florida. Additionally, preferences for items like steak versus fish differ. Due to the subjectivity of value, measuring it for all individuals proves challenging.
The common approach is to utilize the current market value. In the United States, this is quantified in U.S. dollars and aggregated to derive measures of output, including GDP.
Important Facts
There exist alternatives to GDP. For instance, the World Bank utilizes gross national income per capita, which encompasses income repatriated by citizens working abroad, to assess economic growth, categorize countries for analytical endeavors, and ascertain borrowing eligibility.
How To Generate Economic Growth
Economic growth is dependent on the following four contributory areas:
Increase Physical Capital Goods
The first factor involves an increase in physical capital goods within the economy. Augmenting capital typically enhances labor productivity. The introduction of newer, superior, and more plentiful tools enables workers to generate greater output within a given timeframe. For instance, a fisherman equipped with a net can catch more fish per hour compared to one wielding a pointy stick. However, two crucial elements underpin this process:
Firstly, someone within the economy must initiate saving, relinquishing present consumption to free up resources for creating new capital. Additionally, the new capital must be of the appropriate type, situated in the correct location, and available at the opportune moment for workers to effectively utilize it.
Improve Technology
Another approach to fostering economic growth is through technological advancement. An illustration of this is the innovation of gasoline fuel; before the discovery of gasoline’s energy-generating capabilities, the economic value of petroleum was comparatively low. The utilization of gasoline emerged as a superior and more efficient method for transporting goods in the production process and distributing final products.
Enhanced technology empowers workers to generate increased output using the same inventory of capital goods, by integrating them in novel and more efficient manners. Similar to capital growth, the pace of technological progress hinges significantly on the rate of savings and investment, as these are indispensable for engaging in research and development (R&D).
Important Facts
The four factors of production encompass land and natural resources, labor, capital equipment, and entrepreneurship.
Grow the Labor Force
Another method to spur economic growth involves expanding the labor force. All else being equal, a larger workforce generates more economic goods and services. For instance, during the 19th century, a significant portion of the robust U.S. economic growth stemmed from a substantial influx of cheap and productive immigrant labor. However, akin to growth driven by capital, certain key conditions must be met for this process:
Expanding the labor force inherently raises the volume of output needed to sustain the basic subsistence of new workers. Therefore, these new workers must be sufficiently productive to offset this increase and not become net consumers. Additionally, akin to additions in capital, it’s crucial for the appropriate type of workers to migrate to the correct jobs in suitable locations, combined with the right types of complementary capital goods, to fully realize their productive potential.
Increase Human Capital
The final approach is to enhance human capital. This involves workers becoming more proficient in their respective fields, thereby boosting their productivity through skills training, trial and error, or simply increased practice. Savings, investment, and specialization represent the most reliable and readily controllable methods for achieving this.
Human capital in this context can also encompass social and institutional capital. Behavioral inclinations toward heightened social trust and reciprocity, along with political or economic innovations such as enhanced protections for property rights, represent types of human capital capable of augmenting the productivity of the economy.
Why Does Economic Growth Matter?
In its simplest form, economic growth entails an increase in resources available to a broader populace, prompting governments to actively pursue it. However, it’s not solely about financial resources, goods, and services; politics also play a crucial role. How economic growth is leveraged to drive social progress holds significance.
According to a decade-long study by the United Nations University World Institute for Development Economics Research, “most countries that have succeeded in reducing poverty and enhancing access to public goods have done so on the foundation of robust economic growth.” If the benefits are restricted to an elite few, the sustainability of growth is compromised.
How Do Taxes Affect Economic Growth?
Taxes wield an influence on economic growth, especially in the short term, primarily through their impact on demand. A tax cut elevates demand by augmenting personal disposable income and incentivizing businesses to hire and invest. However, the magnitude of this effect hinges on the strength of the economy. If the economy is operating near capacity, the impact tends to be minimal. Conversely, if it operates significantly below its potential, the effect is more pronounced. According to the Congressional Budget Office (CBO), the effect is estimated to be three times larger in the latter scenario than in the former.
Moreover, the CBO asserts that tax cuts generally fall short of government spending increases in terms of stimulating economic growth. This is because while most spending bolsters demand, tax cuts also promote savings alongside demand. One approach to mitigate this effect is by targeting tax cuts toward lower- and middle-income households, as they are less inclined to channel the funds into savings.
What Is Another Word or Term for Economic Growth?
Additional synonyms and phrases for economic growth encompass “boom,” “prosperity,” “economic development,” “economic upswing,” “economic upsurge,” “industrial development,” and “buoyancy of the economy.”
The Bottom Line
Economic growth materializes with an increase in the production of goods and services over a specific period compared to a previous one. Typically gauged through GDP, it serves as a barometer of a country’s economic health. Nonetheless, the extent to which the benefits of growth are distributed widely plays a pivotal role in its sustainability, as well as in societal health and progress.
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Conclusion
Economic development is a broader concept encompassing economic growth. A comprehensive understanding of the economy entails considering both economic growth and development. While economic development is reliant on economic growth, the latter alone is insufficient for fostering economic development.
FAQs on Economic Growth
Q. What is development?
Development refers to the process of improving the well-being and standard of living of individuals and communities. It encompasses various aspects such as economic, social, and environmental progress.
Q. What is the difference between economic development and economic growth?
Economic growth typically refers to the increase in the production of goods and services within an economy, often measured by metrics like Gross Domestic Product (GDP). Economic development, on the other hand, is a broader concept that includes improvements in the quality of life, reduction of poverty, access to education and healthcare, and overall societal progress.
Q. Why is sustainable development essential for economic growth?
Sustainable development ensures that economic growth occurs in a way that preserves natural resources and meets the needs of present generations without compromising the ability of future generations to meet their own needs. By incorporating environmental, social, and economic considerations, sustainable development promotes long-term prosperity and resilience.
Q. Economic growth is usually coupled with?
Economic growth is often accompanied by factors such as increased employment opportunities, rising incomes, technological advancements, infrastructure development, and improved standards of living. However, it is essential to ensure that growth is inclusive and sustainable to benefit society as a whole.
Q. What is sustainable development?
Sustainable development refers to the approach of meeting the needs of the present without compromising the ability of future generations to meet their own needs. It involves balancing economic, social, and environmental considerations to promote long-term well-being and prosperity for all.
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