ECONOMIC GROWTH

ACTUAL VERSUS POTENTIAL GROWTH IN NATIONAL OUTPUT

Economic growth is defined as the percentage increase in the real GDP over a period of time.

For example, if in year 1, GDP of a country was $100B and in year 2 it rises to $110B, then the
rate of economic growth would be 10%. At this point, the distinction between potential growth
and actual growth can be made.

 POTENTIAL GROWTH – this measures the potential growth based on the output capacity
of the economy’s factors of production. The economy’s output capacity is what the
economy could produce if it fully employs all of its resources. This level of output is also
known as the full employment level of output (or the full employment level of GDP).

 ACTUAL GROWTH – this measures the annual percentage increase in the actual output
produced within an economy. For many reasons, the actual growth of the economy may
not always conform to its potential growth level. In fact, there is no guarantee that an
economy would always achieve its potential growth rate due to the existence of
inefficiencies within economic systems.

ECONOMIC GROWTH AND THE PRODUCTION POSSIBILITY CURVE

Economic growth implies a rise in the productive capacity of an economy, which results in an
outward shift of the production possibility frontier. This is depicted in the diagram below:

Figure 1: Economic Growth and the Outward Shift of the Production Possibility Curve
Figure 1 shows an outward expansion of the production possibility curve from P 1P1 to P2P2
occurring as a result of economic growth. This means that people would be able to consume
more goods and services, including leisure. Such higher consumption levels imply a better
standard of living of wellbeing for citizens of the country. This is not necessarily so.

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Factors Influencing Growth

Many factors influence the level of economic activity and hence the rate of economic growth.
Some factors, such as changes in consumer and business confidence, economic growth in a
country’s trading partners and domestic monetary and fiscal policies influence aggregate
spending and this fuels growth from the demand-side of the economy. Other factors which
augment the productive capacity of the economy stimulate growth form the supply-side of the
economy. These factors tend to have a more sustainable long run impact on growth than
demand-side factors.

1. Natural Resources
Natural resources account for all the free gifts of nature which can be used as inputs in
the production process. This includes resources such as agricultural land, surface water,
forests, minerals, and other natural resources. Countries which successfully harness the
productive potential of their natural resources are able to achieve rapid growth.
Jamaica is indeed a prime example of such an economy where the extraction of the
country’s bauxite has contributed to the tremendous rate of growth achieved. It is very
important to mention though, that abundant natural resources by itself may not always
contribute to economic growth if economic agents are unable to successfully exploit
such resources to produce goods and services. This is because the extraction and
utilization of natural resources may require significant investments of capital which may
simply be unavailable. Again, this is the case of Jamaica as much of the developments
which have been undertaken in the bauxite/alumina sector have been financed by
foreign investments.

2. Labour Resources
Economic growth depends on the quality and size of the labour force. Increasing the
quality of the workforce through better education and training increases the value of
human capital and makes workers more productive. The size of the labour force
depends to a large extent on the number of persons of working age. Population growth
(and the associated increase in the labour force) has traditionally been considered a
positive factor in stimulating economic growth. This is because as the labour force
becomes larger, the productive deployment of the additional workers enables more
output to be produced. Furthermore, a larger labour force provides a larger domestic
market which enables large scale production and hence the attainment of economies of
scale. It is important to note though, that if growth in the population outweighs growth
in output, then real GDP per capita would decline.

In addition to an increase in the size of the population, the Government could attempt
to increase the participation rate. The labour force participation rate is the fraction of
the population which belongs to the labour force. To reiterate, the labour force only
includes individuals who are either employed or unemployed. Those who are
considered to be unemployed are those who are able to work, available for work and
actively seeking employment but are unable to find a job. The labour force does not

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 include those who are voluntarily unemployed. Voluntary unemployment exists when
people have chosen not to work and thus remain unemployed. Policies aimed at
reducing voluntary unemployment may seem particularly attractive to Governments as
this would increase the size of the labour force and the participation rate.

3. Capital Resources
In a macroeconomic sense, capital is a factor of production that has two main
components:

a. Physical Capital – this accounts for all tangible assets such as plant and equipment and
machinery which can be used in the production of other goods and services. The
growth of the nation’s stock of physical capital is driven by the level of investment.
Increasing the stock of physical capital, such as new factories, machinery and
equipment, is critical in achieving economic growth as it enables a more efficiency use of
other factors of production such as labour. These directly productive investments are
supplemented by investments in what is known as social and economic infrastructure
such as roads, electricity, water and sanitization, and communications facilities which
integrate economic activities.

b. Human Capital – this is the stock of knowledge, skills and abilities embodied within an
economy’s labour force arising from education, training, and experience. Investments in
human capital formation enable the quality of labour to improve. This implies that
labour productivity rises, enabling greater output from labour resources.

4. Technology
A key determinant of economic growth is technology, which is defined as the application
of practical and scientific knowledge in combining resources to produce goods and
services. New management techniques, scientific research breakthroughs, and other
innovations improve technology. Such technological advances enable the production of
more output from a given amount of resources. This means that scarce resources are
more productively utilized which reduces the real costs of supplying goods and services
and this leads to an outward shift in a country’s production possibilities frontier. This
means that technological progress accelerates economic growth for any given rate of
growth in the labour force and the capital stock.

Technological change depends to a large extent on the educational and scientific

endowment of the economy. The more educated a country’s population, the greater is
its potential for technological advances. To this end, it must be pointed out, that
industrial countries tend to have a relatively higher educational level than developing
countries. This disparity gives industrial countries a substantial advantage over
developing countries in creating and implementing technological innovations.

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 As a result, developing countries depend mostly on developed countries for new
technological developments, which are often expensive and place tremendous strain on
available foreign exchange.

Advantages of Economic Growth

1. More income for society.

2. Increased employment.
3. Poverty reduction.
4. Increased production of goods and services which satisfies more wants and needs and
gives consumers more choice.
5. Higher standard of living and improved economic wellbeing.

Disadvantages of Economic Growth

1. Exhaustion of non renewable resources.

2. Growth may be achieved at the expense of increased noise, congestion, pollution and
other negative externalities which undermine economic welfare.
3. Increased inequality – only the rich may gain the benefits of economic growth whilst the
poor stay poor.
4. Inflation risk – as shown before, in the case of demand induced growth, if the economy
grows too quickly there is the danger of inflation. This type of inflation is called demand
pull inflation, as aggregate demand races ahead of the ability of the economy to supply
goods and services.

ECONOMIC GROWTH – PART 2

An increase in an economy's ability to produce goods and services, therefore increasing

economic output, is possible from any of the following determinants of economic growth:
1. The accumulation of capital.
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 2. Increase in human capital.
3. Improvements in technology.

Economic growth is measured in changes in what is called 'gross domestic product' (GDP). This
is a measure of everything that has been produced in an economy.

Barriers to economic growth

We have seen earlier that the ability to grow an economy depends on using more resources
(land and labour, for example), or on more efficient use of these resources. Economic growth
depends on the quality and availability of the factors of production. If any of the factors of
production suffers from a lack of quality or availability, then economic growth will not be as
great as its potential.

So what can cause these factors of production to be of low quality or unavailable?

 Insufficient or contaminated land
 Substandard labour supply
 Poor technical infrastructure, such as roads and communications
 Poor social infrastructure, such as schools or hospitals
 Poor industrial infrastructure, such as factories and machinery
 Other barriers exist that can hamper countries' ability to grow their economies. They
may be unable to gain access to export markets, due to the trade policies of other
countries. In order to protect their own domestic producers, many countries block the
imports of goods or services from other parts of the world.

The World Trade Organisation (WTO) is a place where member governments go to sort out the
trade problems they have with each other.

Controversies in economic growth

The use of GDP to measure economic growth is not without its critics. Whilst it can be useful in
seeing how different economies are moving over time, GDP is criticised as a measure of how
well-off people are. In other words, GDP is not regarded as a good way of indicating the
standard of living of individuals and households in an economy.

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How well would this family's living standard be illustrated by their country's GDP rate of
growth?

The current measure of GDP is not good at reflecting the damage to the environment caused by
much economic activity. Many observers complain that this means that all economic activity is
seen as a positive event, even though it may harm the environment.

What could be the impact of an oil spill on a city, its region and the overall economy?

In response to this, some countries are planning increased emphasis on environmental national
accounting, where the effects of activity on natural resources are shown and the environmental
impact of growth is highlighted.

Another regular complaint about GDP used as a measure of economic well-being is that it
ignores unpaid, voluntary work. It also fails to value domestic work such as caring and child-
rearing. Some economists have pointed to the benefits that would flow if unpaid or voluntary
work was included in measures of economic activity.

How has an economy developed? Which industries does it depend on? How sustainable are the
routes that a country has chosen to follow towards the goal of growth? Why can't the progress
of a country be measured in ways other than just the amount of goods and services it
produces? How can we measure human happiness? These are all areas of controversy in any
analysis of economic growth.

The United Nations Development Programme (UNDP) publishes its Human Development
Reports annually. A quote from their Web site illustrates well the reason for focusing on the
human aspects of economic activity:

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 Human development is about much more than the rise or fall of national
incomes. It is about creating an environment in which people can develop
their full potential and lead productive, creative lives in accord with their
needs and interests. People are the real wealth of nations. Development is
thus about expanding the choices people have to lead lives that they value.
And it is thus about much more than economic growth, which is only a
means - if a very important one - of enlarging people's choices.

Another major source of controversy in looking at the features of economic growth is the role
played by the International Monetary Fund (IMF), World Bank and WTO in the global economy.
Some critics of these organisations suggest that they represent an 'unholy trinity' of bodies,
which exist to promote the undemocratic interests of large corporations against the wishes of
'the people'.

In an increasingly global economy, these critics argue that less developed countries are forced
to adopt unsuitable policies that favour big business and do little to encourage the reduction of
poverty.

Many of these controversial areas exist on the margins of politics and economics. The trade
policies of the USA towards Cuba and other unfavoured countries attract attention from those
concerned about the lack of growth in some developing economies.

Less developed economies

Less developed economies tend to be in the early stages of industrialisation. In fact many less
developed economies have little or no industrial base. People in countries with less developed
economies usually have a low standard of living. Seen more broadly than just in economic
terms, people in these countries also tend to be ranked in a medium to low position in the
Human Development Index, produced by the UNDP.

Less developed economies are often structured in such a way that agriculture forms a large part
of their overall economy. Small scale or subsistence farming tends to produce low incomes for
the people who work in these countries. This leads to low effective demand for goods and
services other than those that are central to life.

These economies are often characterised by having low levels of private investment. This tends
to be because people are unable to save much of their already low incomes. High fertility rates
are often seen in less developed economies. Children often form part of a family's wealth, as
their labour is often seen as essential to the family's survival (old-age pension as we say
Jamaica).

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Insufficient factors of production usually plague less developed economies. They can lack the
ability to improve the social and technical infrastructure needed to boost their economies and
can become stuck in a cycle of poverty.

The costs of economic growth

One of the main concerns about expanding rates of economic growth focuses on the effects of
congestion, pollution and carbon emissions on the environment. Economic growth in China and
India raises fears that the resulting environmental damage could have serious impacts on us all.
Other observers say that it is hypocritical for those in the developed world to preach to those
trying to develop their economies.

Another cost of economic growth is the loss of ancient ways of life and cultures. As countries
industrialise, natural resources can be lost as more land is sought. The loss of huge areas of the
Brazilian rainforest to cattle-ranching is an example of this effect. In Jamaica, substantial
damage to flora and fauna took place during the construction of a housing development on
Long Mountain. During the clearing of the land, a new species of butterfly was discovered.
Several attempts by environmentalist and conservationists to stop the development failed. We
will never know the full value of what was lost.

Some opponents to the trend towards greater globalisation in industry and economic
development highlight criticisms of economic development that they see as generating large
costs:

 The 'one size fits all' view of economic development prevents subtle differences in the
routes chosen to development.
 The search for faster economic growth may prevent countries concentrating on social
goals such as care for the elderly or children.
 The acceptance of materialism as a general goal in life.
 The homogenised global culture that some observers say has arisen.

Conclusion

When studying the features of economic growth, it's important to remember that there are
many aspects to this topic: how growth is defined; the barriers that exist to growth; the
experience of less developed economies; and the costs of economic growth. In addition, there
are many areas of disagreement among economists, politicians and scientists about many of
the aspects to economic growth.

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