UNIT 1 INTRODUCTION TO

ECONOMIC GROWTH
Structure
1.0 Objectives
1.1 Introduction
1.2 What is the Economic Growth
1.3 Economic Growth and Development: A Contrast
1.4 Growth Performance of the World Economy
1.5 Why Study the Process of Economic Growth?
1.6 The Importance of Economic Growth
1.7 Sources of Economic Growth
1.8 Limitation of Economic Growth
1.9 Let Us Sum Up
1.10 Key Words
1.11 Some Useful Books
1.12 Answers/ Hints to Check Your Progress Exercises

1.0 OBJECTIVES
The goal of this unit is to understand the concept of economic growth and examine
how different countries have performed in terms of their growth over the years. After
going through the unit you would be able to :
• Define the concept of economic growth;
• Contrast between economic growth and economic development;
• Describe the growth performance of the world economy; and
• Explain the importance of the study of economic growth.

1.1 INTRODUCTION
The question of growth is nothing new but a new disguise for an
age-old issue, one which has always intrigued and preoccupied
economics: the present versus the future
- James Tobin

If you speak to your parents and grandparents about their life when they were young,
you will find that your standard of life is much higher than theirs. The material
standards of living have substantially improved for most of the people in the last few
decades in most countries. This improvement in standard of living has come from
rising levels of incomes and which has made it possible for people to consume higher
quantities of goods and services as well as they are of better quality.
Economists have always known that growth is an essential ingredient for economic
development. Economic growth and change are part of the normal experience of
economic life of societies. This course attempts to explain how economic theory can
be used to gain better understanding of the process of economic growth and change.
Though there are no universal laws which govern the process of economic growth
but there are many economies that face a relatively small set of dominating
constraints on their process of growth and structural change. While economics by
itself cannot offer a satisfactory explanation of either particular historical experiences

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Economic Growth Models-I or some general phenomena, such as technical progress, it can offer valuable insights
into the fundamental process of growth in these economies (Chaudhuri, 1989, p 1).

Paul Romer (1996) has tried to explain the process of economic growth using an
interesting analogy. In his words, ‘Economic growth occurs whenever economic
agents take resources and rearrange them in ways that are more valuable. A useful
metaphor for production in an economy comes from the kitchen. To create valuable
final products, we mix inexpensive ingredients together according to a recipe. The
cooking one can do is limited by the supply of ingredients, and most cooking in the
economy produces undesirable side effects. If economic growth could be achieved
only by doing more and more of the same kind of cooking, we would eventually run
out of raw materials and suffer from unacceptable levels of pollution and nuisance.
Human history teaches us, however, that economic growth springs from better
recipes, not just from more cooking. New recipes generally produce fewer
unpleasant side effects and generate more economic value per unit of raw material’.
Each successive generation tends to perceive the limits to growth that finite resources
and undesirable side effects would pose if no new recipes or ideas were discovered.
But every generation has also underestimated the potential for finding new recipes
and ideas. Human beings consistently fail to grasp how many more ideas are yet to
be discovered. Possibilities do not add up, they multiply with time and people as they
interact.

1.2 WHAT IS ECONOMIC GROWTH?

Today economic growth is everybody's concern and in such a milieu growth process
and growth theory has received particular attention of economists and policymakers.
Yet surprisingly, there is no universally acceptable definition of the term. Different
economists have used the term 'economic growth' to convey different meanings.
In very simple English ‘economic growth’ occurs whenever people take resources
and rearrange them in ways that are more valuable to the society. Economic growth
may be defined as a rate of expansion that can move an underdeveloped country
from a near subsistence mode of living to substantially higher levels in a
comparatively short period of time, i.e. in decades rather than centuries. Historically,
rapid economic growth has been accompanied by greater industrialization. But more
precisely the process of economic growth can be described in terms of greater
commercialisation of economic activities. Though this concept is correct in essence,
it lacks precision and makes its measurement difficult.
Economic growth Defined: A simple definition is that it is an increase in the level
of output of goods and services that is sustained over a long period of time, measured
in terms of value added.
Process of economic growth is essentially a dynamic concept and refers to a
continuous expansion in level of output, i.e. it refers to forces that generate a positive
rate of change over time and not the forces that lead to discrete (or one shot) change
from a lower to higher level of output which are temporary and short lived.
The term output expansion, however, is subject to ambiguity in the sense that does it
mean growth in total output or growth in output per capita. An increase in the former
is referred to as ‘extensive’ growth whereas an increase in the latter is called the
‘intensive’ growth. The latter one is important in the context of increase in the
standards of living of the population of the country whereas the former is extremely
significant when one wants to examine the aggregative phenomenon such as
economies of scale etc (Chaudhuri, 1989, p. 2).
Here distinction needs to be made between level of output and output capacity. Most
growth theories implicitly deal with changes in output capacity, whereas actual
changes in output over time are influenced by the ability of an economy to utilize the
existing capacity effectively. In this context it is important to keep in mind that for a
particular economy, growth of output at two points in time may be significantly
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influenced by different degrees of utilisation of capacity for relevant periods. In the Introduction to Economic
Growth
analysis of long term one cannot ignore the effects of the short run completely.

Another important issue in the context of growth process is the incorporation of the
changes in the quality that tends to be integrated part of the growth process. Factor as
well as commodity markets both are characterised by theses changes. For instance in
the commodity markets economic growth leads to not only increased output but also
to newer and, many times, better products. In the factor markets economic growth
brings improvements in skills of workforce and/or more efficient and/or safer types
of machinery. The process of economic growth may also lead to changes in the form
of economic activity which referred to as structural shift in the economic structure of
an economy. This means that the economy moves away from being largely rural and
agriculture based to urban and industry dominated. The most fundamental change by
far that economic growth creates is the widening of range of choices that become
available to an economy. Economic growth creates the potential for the society to
usher in healthier, better educated population and improve the quality of life for its
citizens. Here it must be kept in mind that the current state of theories of economic
growth is far from adequate in incorporating the qualitative aspects of the
phenomenon of economic growth (P. Chaudhuri, 1989, p. 3).

1.3 ECONOMIC GROWTH AND

DEVELOPMENT: A CONTRAST
As discussed above, in the recent literature the term economic growth refers to
increases over time in a country's real output of goods and services. Output is
generally measured by gross or net domestic product (GDP or NDP), though other
measures can also be employed. The term economic development, in contrast, is
much more comprehensive. It implies progressive changes in the socio-economic
structure of a country. Viewed in this way, economic development involves a steady
decline in agriculture's share in the GDP and a corresponding rise in the share on
industrial sector as well as of the economic (productive) services. This
transformation in the economic structure is invariably accompanied by a shift
occupational structure of labour force and an improvement in its skill and
productivity.

Compared to the objective of development, economic growth is far easier to realise.

This is because process of development is far more pervasive. Apart from a rise in
output, it involves changes in the composition of output as well as a shift in the
allocation of productive resources so as to ensure social justice.

Many times in the discussions we tend to use growth and development

interchangeably. A growth in the real income is supposed to contribute to general
rise in the standard of living of the people in general. But growth and development
need not be the same. The average per capita income figures are derived by dividing
total real income by the population of the country. But it does not say anything about
the distribution of income, occupational structure, share of agriculture and industry
in economic activity (Ghatak, 2003, p. 23).

Check Your Progress 1

1) What is the definition of Economic Growth?

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Economic Growth Models-I 2) What is the difference between economic growth and economic development?

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3) How is ‘extensive’ economic growth different from ‘intensive’ economic

growth?

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4) Which is a better indicator for assessing the growth performance of an economy

and why?

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1.4 GROWTH PERFORMANCE OF THE WORLD

ECONOMY
From the earliest historical times until around the beginning of the 19th century, the
number of people in the world and the volume of goods and services they produced
grew at roughly equal and slowly increasing rates. The living standards of ordinary
people in the 18th century Europe were about the same as those of people in
contemporary China or ancient Rome or of people in the poorest countries in the
world today. Then during the last two centuries, both production and population
growth accelerated drastically with production growth outpacing the growth in
population. It was for the first time in history that living standard of the ordinary
people began to undergo sustained growth. This was made possible by the rapid
economic growth in the world economy in this period

In 1800, incomes per capita differed by perhaps a factor of two between the richest
and poorest nations. It was to explain this difference in income that Adam Smith
undertook the task of writing Wealth of Nations. Today the difference between the
per capita income of the richest and poorest country is about 300 times (see Table
1.1). This gives the indication of how little we know about growth dynamics and
much more we need to stress on study of the process of economic growth.

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Economic growth in the second half of the twentieth century has been miraculously Introduction to Economic
Growth
different from any earlier period in history that our previous generation may find it
difficult to believe it. Production in the world as a whole grew at more than 4 per
cent per year whereas the population grew at around 2 per cent. The real income of
an average person has more than doubled since the World War II

The growth in per capita income has been uneven across countries over the years.
Some countries have grown at very fast pace while others have lagged behind. In any
given year, one could observe large differences in the standard of living among
countries. Table 1.1 shows GDP and GDP per capita in the world’s 22 countries
across different continents in 1990 and 2000. As we can see from this table that
China’s has grown at the fastest rate of over 10 per cent per annum in the nineties.
India has also grown at a relatively fast pace in this period of around 6 percent.
Although India’s growth is much slower than that of China’s as also the population
growth in India’s higher than that of China’s. Due to this the per capita income has
grown at even slower pace in former. The highest per capita are Japan and the U.S.
with per capita GDP of US $ 36828 and 35046 respectively.

Table 1.1: GDP and GDP per capita across countries – 1990 and 2000

G.D.P. G.D.P.
GDP per GDP-per CARG*
↓Countries ($ million) capita ($) ($ million) capita ($) GDP
Year → 1990 2000 1990-2000
Ethiopia 4020.7 78.9 6304 99 4.6
Kenya 8456.6 357.3 10410 347 2.1
Pakistan 42885.2 397.8 61673 447 3.7
India 267696.7 314.9 479404 472 6.0
China 405182.0 354.9 1079954 856 10.3
Egypt 62716.6 1194.5 98333 1537 4.6
Iran 69501.4 1272.8 98990 1547 3.6
Tanzania 6865.0 266.1 9316 274 3.1
Namibia 2327.8 1489.9 3479 1740 41
Russia 410642.0 2756.9 251092 1720 -4.8
Brazil 441462.0 2984.2 587553 3456 2.9
South Africa 103271.2 2927.6 125887 2928 2.0
Korea, Republic 262648.2 6172.9 457219 9728 5.7
New Zealand 37192.0 10372.9 49983 12496 3.0
Sweden 190218.8 21996.2 227369 25263 1.8
United Kingdom 1104170.8 19152.4 1413432 23557 2.5
Japan 4110381.3 33349.4 4677099 36828 1.3
France 1086717.2 19169.1 1286252 21801 1.7
Germany 1611434.9 20249.2 1870136 22807 1.5
Australia 263641.8 15633.8 394023 20738 4.1
Canada 518097.4 18461.3 689549 22244 2.9
United States 7074185.8 28263.9 9882842 35046 3.4

Note: CARG* refers to compound annual rate of growth.

Source: World Bank, World Development Report, 1992, 2002, and 2004.
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Economic Growth Models-I In the following table we could see the performance of different countries across
different categories: High income and low income countries over last four decades.
As we can note from the Table 1.2 here also China has been the best performer in
this period followed by South Korea and Taiwan. India is also among the high
growth countries in the developing world though not growing as fast due to various
reasons. The performance of China and India in the last few years has improved
further which gets reflected in the previous table (as discussed earlier). There is no
doubt that this performance is far superior to many of the countries in the developing
world which have contracted in this period, prominent ones being Congo, Sierra
Leone, and Niger.
Table 1.2: The growth of per-capita GDP for high-income industrial countries, high-
growth LDCs, and low-growth LDCs, (1980–1999)

High-growth LDCs High-income Countries Low-growth LDCs

China 8.2 Japan 2.2 Congo (Zaire) -4.7
South Korea 5.8 Australia 2.1 Sierra Leone -3.5
Taiwan 5.3 United States 1.9 Niger -2.5
Singapore 4.8 United Kingdom 1.9 Haiti -2.2
Thailand 4.7 Italy 1.8 Côte d’lvoire -2.2
Ireland 4.4 Netherlands 1.8 Zambia -2.0
Hong Kong 3.9 France 1.6 Madagascar -1.8
India 3.7 Germany 1.5 Nicaragua -1.8
Malaysia 3.7 Canada 1.4 Central African Republic -1.3
Chile 3.6 Switzerland 0.9 Nigeria -1.1
Source: World Bank, World Development Indicators, 2001; and Republic of China, Statistical Yearbook of the Republic of China, 2000.
NOTE: Only countries with a population of 2 million or more in 1999 are included.

The Table 1.3 further goes in details of growth performance and examines the level
of GDP and GDP per capita for these economies from 1950 to 1998, almost half a
century. The subdivision of the periods are 1950, 1973 (first oil-shock period), 1990
(spurt in globalization process), and 1998. These numbers are taken from Maddison
(2003). We can see in the Table that South Korea, Japan, and China have
experienced the fastest growth in terms of GDP as well as GDP per capita from
1950-1998. This data is not for the latest year as the methodology adopted by
Maddison (2003) is different as compared to others such as the World Bank.
Therefore, the Tables 1.1 and 1.2 are not comparable.

Table 1.3: GDP and GDP per capita across countries – 1950 and 1998

G.D.P. G.D.P. G.D.P.

($ ($ ($ G.D.P. ($ CARG- CARG-
Countries million) pcy* million) pcy* million) pcy* million) pcy* GDP pcy
1950 1973 1990 1998 1950-1998
Ethiopia 5394 250 13640 401 18964 372 24883 400 3.24 0.99
Kenya 3982 653 12107 961 26093 1101 30451 1075 4.33 1.04
Pakistan 25366 643 67828 954 182014 1598 261497 1935 4.98 2.32
India 222222 619 494832 853 1098100 1309 1702712 1746 4.33 2.18
China 239903 439 740048 839 2109400 1858 3873352 3117 5.97 4.17
Egypt 15224 718 36249 1022 112873 2012 140546 2128 4.74 2.29
Iran 28128 1720 171466 5445 199819 3586 274695 4265 4.86 1.91
Tanzania 3362 378 9007 588 13852 556 16933 553 3.43 0.80
Namibia 1002 2159 2895 3484 4619 3278 6158 3797 3.86 1.18
USSR* 510243 2834 1513070 6058 1987995 6871 1132434 3893 1.67 0.66
Russia 872466 6577 1151040 7762 664495 4523 -0.77 -1.06

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 Introduction to Economic
Growth
Brazil 89340 1672 401643 3882 743765 4924 926919 5459 4.99 2.50
South Africa 34465 2534 102498 4167 147509 3965 165239 3858 3.32 0.88
Korea, Rep 16045 770 96794 2841 373150 8704 564211 12152 7.70 5.92
New
Zealand 16136 8493 37177 12518 46729 13825 56322 14822 2.64 1.17
Sweden 47269 6738 109794 13488 151451 17672 165385 18688 2.64 2.15
United Kingdom 347850 6907 675941 12023 944610 16411 1108568 18714 2.44 2.10
Japan 160966 1926 1242932 11334 2321153 18795 2581576 20413 5.95 5.04
France 220492 5270 683965 13123 1026491 18092 1150080 19558 3.50 2.77
Germany 265354 3881 944755 11965 1264438 15925 1460069 17799 3.62 3.22
Australia 61274 7491 172314 12764 291180 17028 382335 20337 3.89 2.10
Canada 102164 7436 312176 13838 524475 18934 622880 20559 3.84 2.14
United States 1455916 9561 3536622 16689 5803200 23214 7394598 27331 3.44 2.21
Source: Maddison, 2003. NOTE: pcy* refers to GDP per capita.

As for the performance of Indian economy is concerned, over the years, it has been
growing steadily. The real GDP of India in 2003/04 was Rs. 1567399 crores which is
more than 10 times its 1950 level, and the real GDP per person in 2003/04 was
Rs. 14607 which is more than 3.5 times what it was in 1950 i (RBI, 2004 ii ).
Compared to the pre-Independence period, it has been impressive performance but as
we saw above it is far from satisfactory and well below the best performing
economies in our close neighbourhood.

1.5 WHY STUDY THE PROCESS OF ECONOMIC

GROWTH?
What is it about the economic growth that we need to spend so much time in
studying the economic growth process in details? There could be various reasons for
doing so. Some of the important ones are as follows:
1) It enables us to gain a better understanding of an important historical process.
For instance we may want to understand
a) Why Britain was the first country to industrialise? Or
b) Why even after having the head start Britain has fallen behind the United
States, Germany and Japan and, more recently, to many other west
European countries?
c) Why economic growth has been concentrated in the relatively small part of
the world economy of Western Europe, North America and parts of Asia?
d) What were the reasons for rapid economic growth of the East and South
East Asian economies for almost three decades and what about China in
last two decades – that seems to have outshined all previous growth
experiences and showing no signs of slow down?
Economic theory of growth is essential for answering all these questions
though it may not be sufficient. This is because the growth theory has not
developed adequately to explain some important phenomenon like technical
progress or the welfare consequences of growth.
2) It may also be because the historical experience of each of the economy has
some unique characteristics which involve forces some of which may not be
possible to duplicate in another economy. Economic theory, in these
circumstances, can suggest some hypotheses while rejecting the others, as to 13
Economic Growth Models-I why growth occurs at different rates at different times across countries. In the
process it can also identify some strategic variables in the process, such as
increases in agricultural productivity, or rate of capital accumulation etc. More
on these and related issues will be discussed in the later Units in this course.
3) It may also be because the historical experience of each of the economy has
some unique characteristics which involve forces some of which may not be
possible to duplicate in another economy. Economic theory, in these
circumstances, can suggest some hypotheses while rejecting the others, as to
why growth occurs at different rates at different times across countries. In the
process it can also identify some strategic variables in the process, such as
increases in agricultural productivity, or rate of capital accumulation etc. More
on these and related issues will be discussed in the later Units in this course.
4) Understanding of economic growth process may help in formation of economic
policy. In the sphere of policy it is not always possible to make a distinction
between short and the long run. For instances short run policies to stabilise and
economy may have quite different long term ramifications, whether it is
exchange rate or monetary or fiscal policies as they have differential impact on
the consumption and investment in the economy. One of the reasons why
Keynesian policies iii : were so popular across the world was that it identified
rate of investment as a key policy variable but it proved to be inadequate
because it was not able to offer any potential relationships between
productivity and real wages.

1.6 THE IMPORTANCE OF ECONOMIC

GROWTH
The relationship between wealth resulting from rapid growth and happiness is
difficult to establish. As there is no unambiguous evidence that rich are happier than
the poor, or that individual grow happier as their incomes increase. In so far as
economic growth results from alertness in seeking out and seizing economic
opportunities, it is to be expected that it should be associated with less happiness.
There is some evidence to suggest that a far higher level of psychological
dissatisfaction in the U.S. and Japan – country with one of the highest level of per
capita income–than there is in most of the low income economies of Asia and Africa.
Cross country differences in growth rates over a few decades substantially alters
relative income. From 1960-1999, per capita income growth in Argentina and
Venezuela was 1% and - 0.1% respectively. In the same period, the growth rates of
Japan and Hong Kong were at much higher level of 4.4% and 5.4% respectively.
Note how the rapid growth rates of the two Asian economies dramatically altered
their relative incomes compared to the other two economies.

Per-Capita Income
(in thousands of 1985 U.S. Dollars)

4,462 1960
Argentina 6,593
1999
6,338
Venezuela
6,118
2,954
Japan 15,835
2,247
Hong Kong 17,693

Source: Robert Summers and Alan Heston, Penn World Tables

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Besides there are many more advantages of the process of growth. Some of these are Introduction to Economic
Growth
listed below:

1) The advantage of economic growth is not that it increases happiness but it

creates potential for wider range for human choice (tangible as well as
intangible). In other words economic growth gives us freedom to enjoy greater
leisure or more material wealth (in form of goods and services) or some
combination of the both. In poor countries around 50–70 per cent of population
works in agriculture to feed everyone whereas in rich countries less than
10 per cent are enough to do the job. So, in the latter countries there are much
larger number of people who are available for other activities (such as medical
science, education, scientific research, entertainment etc.). So, economic
growth makes it possible to release people from basic task of growing food to
more complex and interesting economic activities.

2) Rapid economic growth is one of the important instruments to resolve social

tensions which tend to result from different segments of populations trying to
extract more and more than already have, e.g. workers asking for higher
wages, better housing, education, health and other amenities. If the level of
income in the economy is stagnant then desires of one group could be met only
at the cost of the other groups which tend to cause social conflicts. Through
rapid economic growth this conflict to a very large extent could be avoided.
Due to this reason, policymakers and political leaders should need no
convincing for the urgency of stimulating growth (Lewis, 1955).

3) What distinguishes humans from the other creatures is that we have greater
control over our environment but not that we are happier. So, from this
perspective economic growth is desired greatly. There is no doubt that
economic growth increases control of humans over their environment and
thereby expanding their freedom and horizon. Higher levels of income
resulting from rapid economic growth free life from nature’ menaces of death
and diseases.

4) In the process of economic growth women are likely to benefit far more than
the men. In most low income economies, most of the household tasks are done
by women and many of these are done by the mechanical devises in the
advanced societies – such as grinding grains, washing clothes and dishes,
cooking among others. economic growth transfers many of these and many
other tasks like spinning and weaving, teaching children, minding the sick to
external establishments which are specialized at doing these with the scale
advantages. In the process women gains freedom from drudgery and
emancipated from seclusion of the household, gains at last the chance for being
complete human being exercising her mind and her talents in the same way as
men (Lewis,1955).

5) Economic growth also permits mankind to indulge in the luxury of greater

humanitarianism as at higher level of income they can afford to forgo part of
their income to uplift others who have not been so fortunate (Lewis,1955).

6) Economic growth process has been found to by far the most effective tool to
alleviate poverty. There is lot of evidence to suggest that income inequalities
tends to worsen at the initial stages as the economy grows but there is very
little evidence of worsening of poverty. The best example of this is this is the
experience of China, India iv and countries of East and South East Asian
economies in the past two to three decades characterized by rapid economic
growth. In the literature, this effect of growth on poverty is known as the
trickle down effect. So rising inequalities and lower poverty tend to go hand in
hand in the process of economic growth.

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Economic Growth Models-I This is not exhaustive list but give us some idea about how process of economic
growth could benefit a society and correspondingly its citizens.

Check Your Progress 2

1) Describe the broad contours of the growth of nations in the second half of the
twentieth century.

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2) What in your opinion would be the main reasons for studying the growth of
nations? What useful knowledge can we obtain?

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3) Discuss any three advantages of economic growth.

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1.7 SOURCES OF ECONOMIC GROWTH

Economic growth is a complex process that generally involves several interrelated
factors. Economists stress the importance of three major sources of economic
progress:
a) investment in physical and human capital,
b) technological advances, and,
c) institutional and policy changes that improve the efficiency of economic
organisation.
i) competitive markets,
ii) stable prices,
iii) free trade,
iv) flexible capital markets,
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 v) avoidance of high marginal tax rates Introduction to Economic
Growth
vi) secure property rights, and
vii) political stability,
However, here we must remember that in a country's growth process the role of
economic factors is crucial and decisive. The stock of capital and the rate of capital
accumulation in most cases settle the question whether at a given point of time a
country will grow at what pace. There are few other economic factors which also
have some bearing on development but their importance is hardly comparable to that
of capital formation.

Capital Formation: More capital generally means more production, and more
production means more growth. To get capital, countries have to invest and so the
level of investment may be a big determinant of future growth. So, Capital formation
is of crucial importance in the process of economic growth. It is quite necessary to
step up the rate of capital formation so that a large capital stock of machines, tools
and equipment could be accumulated which can be geared into faster growth in the
level of production of goods and services. Not only that, capital formation requires
the creation of skill formation so that the physical appearance requires the creation of
skill formation so that the physical apparatus or equipment created can be utilised to
raise the level of productivity. In the words of Indian Planning Commission "The
level of production and the material well-being a community can attain depends, in
the main, on the stock of capital at its disposal, i.e. on the amount of land per capita
and of productive equipment in the shape of machinery, buildings, tools and
implements, factories, locomotives, engines, irrigation facilities, power installations
and communications. The larger the stock of capital, the greater tends to be the
productivity of labour and, therefore, the volume of commodities and services that
can be turned out with same effort" (First Five Year Plan p 13).

Experiences of other countries in other countries suggest that a high rate of capital
formation was achieved to trigger rapid economic growth. In Japan, investment rate
between 1913 and 1939 averaged 16 to 20 per cent. The First Five Year Plan of the
Soviet Union had a target of net investment amounting "between a quarter and a third
of national income" though in the subsequent plans the rate of investment was
lowered and stabilised at about 20 per cent of national income. In some of the East
European countries like Czechoslovakia and Poland, gross investment rates ranged
between 20 and 25 per cent.

Capital-Output Ratio: Another determinant of economic growth is the capital-

output ratio. The term 'capital-output ratio' refers to the number of units of capital
that are required in order to produce one unit of output. In other words, capital-
output ratio reflects the productivity of capital in the various sectors of the economy
at a point of time. The capital-output ratio for the economy as a whole is only a
shorthand description of the productivity of capital.

The capital-output ratio is different for different industries and different economies
and it varies over a period of time. According to Indian First Five Year Plan "There
is no unique capital-output ratio applicable to all countries at all times. Much
depends on the stage of economic development reached but also on the precise form
of further expansion.” For instance in the early phase of growth process, when a
country is making heavy investment in economic infrastructure, i.e. on building
irrigation works, hydro-electric projects, roads, railways, etc. the corresponding
additions to output will be small. But with passage of time as the power potential
and transport equipment are utilised to the full, there shall be a favourable shift in the
capital-output ratio. Similarly, basic industries like iron and steel, machine tools,
engineering and metallurgy are more capital-intensive than consumer goods
industries. Consequently in the initial years of development when the economic
foundations are being laid, capital-output ratio tends to be unfavourable. But as
development gathers momentum, and the emphasis is shifted to the production of 17
Economic Growth Models-I consumer goods, relatively smaller increases in investment bring about large
increments to output. In other words, the stage of growth and the mix of various
types of investment determine the capital-output ratio.

Besides, in certain sectors of the economy output can be increased with

comparatively small additions to output, while in other sectors, comparatively large
additions to capital are called for. For instance, in Japan, between 1885 and 1915,
labour productivity in agriculture was doubled by a comparatively small quantum of
investment in the form of better seeds, improvements in water supply, control of crop
diseases and use of fertilizers. In additions to this, capital-output ratio depends upon
the efficiency with which the new types of capital equipments are handled and the
quality of managerial and organisational skill becomes available. Co-ordination of
the programme of investment so as to develop complementary economic activity
simultaneously has a favourable effect on capital-output ratio. In other words, the
capacity of the economy to more effectively use the investment at a particular time
also affects the capital-output ratio.

The rate of growth of national income in an economy depends upon the rate of
investment and the capital-output ratio:
Investment - Income Ratio
i.e. Rate of Growth of GDP = --------------------------------------
Capital - Output Ratio
In other words, to achieve high rate of growth of national output, economy has to
operate on two variables, viz
a) to step up the rate of investment; and
b) to generate forces which improve productivity;

Occupational Structure: Another factor which determines and is determined in due

course by economic growth process is the occupational structure of the working
population. Experience from all over the world suggests that in the process of
growth, transfer of working force from primary to secondary and then secondary to
tertiary sector of the economy has invariably taken place. For instance between 1870
and 1930, the proportion of work force engaged in agriculture declined from 54 to 23
per cent in U.S.A., from 43 to 25 per cent in France, and 80 to 48 per cent in Japan.
It is, therefore essential that as growth proceeds there is an optimum distribution of
the work force in different occupations. As this improves the efficient utilisation of
labour which will further boost the overall level of productivity of the economy.

Technological Progress: This is perhaps the most widely accepted (and easiest to
understand) source of economic growth. This is because technology makes it
possible to produce more from the same quantity of resources (or factors of
production). This boosts the potential level of out put of the economy. The pace of
technological change will depend on:
a) the scientific skills of the country
b) the quality of education
c) the amount of GDP devoted to research and development
In the next section we will discuss the limitations of the economic growth in details
for your clearer understanding of the underlying process of economic growth to
enable you to critically evaluate it.

1.8 LIMITATION OF ECONOMIC GROWTH

The process of economic growth has certain limitations as well. Thus we should not
lose sight of these in the blind race of growth as these could have serious social and
18
economic repercussions for the society (as happened in many of the Latin American Introduction to Economic
Growth
countries).

1) Inequality of income –growth rarely delivers its benefits evenly. So the issue
of distribution of the fruits of the growth process becomes first important
limitation of process of economic growth. There is evidence to suggest that, al
least in the initial stages of development; growth tends to worsen the
distribution of income. Although the relationship between growth and
distribution is far from settled. There is no doubt that rapid economic growth
creates the potential means for alleviating the problem of poverty which affect
almost all the developing countries. With adequate state intervention, this
potential has been used to significantly reduce the poverty incidence in the
economies of East and South East Asian economies as well as China. It is
possible to have economic growth without the majority of population being
any better off, as the expanded output enriches only a small section of
powerful population. But such developments are immoral, and would result in
more social conflicts and could undermine the economic policymaking which
benefit only a few (Lewis, 1955).

2) Pollution (and other negative externalities) – the drive for increased output
tends to put more and more pressure on the environment and the result will
often be increased pollution – air, water, and noise. This may be water or air
pollution, but growth also creates significantly increased noise pollution.
Traffic growth and increased congestion are prime examples of this.

3) Loss of non-renewable resources – the more we want to produce, the more

resources we need to do that. The faster we use these resources, the less time
they will last. This invariably leads to loss of non-renewable resources like oil,
and other minerals, forests etc. It is clear that economic growth, by either
increasing the total availability of goods and services, or by increasing the
capacity to do so, makes it possible for people to reach higher level of material
welfare for some commodities and at present. However, economic growth
process may reduces social welfare as sometimes increasing the level of output
may lead to relative scarcity of some other resources or same factors for future
generations and could make it more difficult for them to maintain the present
level of welfare in the times to come.

Check Your Progress 3

1) Discuss the three main sources of economic growth.
……………………………………………………………………………………

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2) Discuss some limitations of economic growth.

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…………………………………………………………………………………… 19
Economic Growth Models-I
1.9 LET US SUM UP
The importance of economic growth cannot be overstated. Income growth is
essential for achieving economic, social, and even political development. In recent
years, an enormous amount of talent and effort has been invested in understanding
the process of economic growth, making it one of the most dynamic fields in
economic analysis.

In this unit the concept of economic growth was discussed in detail. We also
understood the difference between the concept of economic growth and
development. The unit also elaborated about why we need to study the process of
economic and its importance. We also examined the performance of the countries
over last five decades. We ended the unit with discussion of limitation of economic
growth.

1.10 KEY WORDS

Gross Domestic Product: Measures level of economic activity in an economy’s
boundaries in a particular time period, normally a year or a quarter.

Income per capita: This is calculated by total gross domestic product of a country
divided by total population. Per capita income is often used as an indicator of level
of living and development. It, however, can be a biased index because it takes no
account of income distribution.

Economic growth: A simple definition is that it is an increase in the level of output

of goods and services that is sustained over a long period of time, measured in terms
of value added.

Extensive growth: This refers to growth in total output level of an economy.

Intensive growth: This refers to growth in per capita output level in an economy.

Trickle-down effect: This effect refers to the negative link between incidence of
poverty and the process of economic growth

1.11 SOME USEFUL BOOKS

Ahluwalia, M.S., (1977), “Agricultural Growth and Rural Poverty”, Journal of
Development Studies.

Barro, Robert & Xavier Sal-i-Martin, (2004) Economic Growth, Second Edition.

M.I.T. Press, Cambridge, Massachusetts

Ghatak, S. (2003) Introduction to Development Economics, , Routledge, London,

Lewis, W. Arthur (1955) Theory of Economic Growth, George Allen & Unwin,
London,

Lucas Robert E. Jr, (2002) Lectures on Economic Growth, Harvard University Press,
Cambridge,Massachusetts

Maddison, Aungus (2003) The World Economy: A Millennial Perspective, Overseas

Press (India) Limited, New Delhi.

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 Introduction to Economic
1.12 ANSWERS / HINTS TO CHECK YOUR Growth
PROGRESS EXERCISES

Check Your Progress 1

1) See section 1.2 and answer.
2) See section 1.3 and answer.
3) See section 1.3 and answer.
4) See section 1.3 and answer.
Check Your Progress 2
1) See section 1.4 and answer.
2) See section 1.5 and answer.
3) See section 1.6 and answer.
Check Your Progress 2
1) See section 1.7 and answer.
2) See section 1.8 and answer.

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