Economic growth

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Image:World GDP Capita 1-2003 A.D.png
World GDP/capita changed very little for most of human history before the industrial revolution. (Note the empty areas mean no data, not very low levels. There are data for the years 1, 1000, 1500, 1600, 1700, 1820, 1900, and 2003.)

Economic growth is the increase in value of the goods and services produced by an economy. It is conventionally measured as the percent rate of increase in real gross domestic product, or GDP. Growth is usually calculated in real terms, i.e. inflation-adjusted terms, in order to net out the effect of inflation on the price of the goods and services produced. In economics, "economic growth" or "economic growth theory" typically refers to growth of potential output, i.e., production at "full employment," which is caused by growth in aggregate demand or observed output.

As economic growth is measured as the annual percent change of National Income it has all the advantages and drawbacks of that level variable. But people tend to attach a particular value to the annual percentage change, perhaps since it tells them what happens to their wage cheque.

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[edit] Origins of the concept of economic growth

In the early modern period, some people in Western European nations began conceiving of the idea that economies could "grow", that is, produce a greater economic surplus which could be expended on something other than religious or governmental projects (such as war). The previous view was that only increasing either population or tax rates could generate more surplus money for the Crown or country.

Now it is generally recognized that economic growth also corresponds to a process of continual rapid replacement and reorganization of human activities facilitated by investment motivated to maximize returns. This exponential evolution of our self-organized life-support and cultural systems is remarkably creative and flexible, but highly unpredictable in many ways. Since science still has no good way of modeling complex self-organizing systems, various efforts to model the long term evolution of economies have produced few useful results.

During much of the "Mercantilist" period, growth was seen as involving an increase in the total amount of specie, that is circulating medium such as silver and gold, under the control of the state. This "Bullionist" theory led to policies to force trade through a particular state, the acquisition of colonies to supply cheaper raw materials which could then be manufactured and sold.

Later, such trade policies were justified instead simply in terms of promoting domestic trade and industry. The post-Bullionist insight that it was the increasing capability of manufacturing which led to policies in the 1700's to encourage manufacturing in itself, and the formula of importing raw materials and exporting finished goods. Under this system high tariffs were erected to allow manufacturers to establish "factories". (The word comes from "factor", the term for someone who carried goods from one stage of production to the next.) Local markets would then pay the fixed costs of capital growth, and then allow them to export abroad, undercutting the prices of manufactured goods elsewhere. Once competition from abroad was removed, prices could then be increased to recoup the costs of establishing the business.

Under this theory of growth, the road to increased national wealth was to grant monopolies, which would give an incentive for an individual to exploit a market or resource, confident that he would make all of the profits when all other extra-national competitors were driven out of business. The "Dutch East India company" and the "British East India company" were examples of such state-granted trade monopolies.

It should be stressed that Mercantilism was not simply a matter of restricting trade. Within a country, it often meant breaking down trade barriers, building new roads, and abolishing local toll booths, all of which expanded markets. This corresponded to the centralization of power in the hands of the Crown (or "Absolutism"). This process helped produce the modern nation-state in Western Europe.

Internationally, Mercantilism led to a contradiction: growth was gained through trade, but to trade with other nations on equal terms was disadvantageous. This – along with the rise of nation-states – encouraged several major wars.

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 would then argue 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.

This 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. In this modern view, the role of technological change became crucial, even more important than the accumulation of capital.

Income per capita was essentially flat until the industrial revolution. This period of time is called the Malthusian period, since it was governed by the principles explained by Thomas Malthus in his "Essay on the Principle of Population." In essence, Malthus said that any growth in the economy would translate into a growth in population. Thus, although aggreagate income could increase, income per capita was bound to stay roughly constant. The mainstream theory of economic growth states that with the industrial revolution and advancements in medicine, life expectation increased, infant mortality decreased, and the payoff to receiving an education was higher. Thus, parents began to place more value on the quality of their children and not on the quantity. This lead to a drop in the fertility rates of most industrialized nations. This is known as the breakdown of the Malthusian regime. With income increasing drastically and population dropping, industrialised economies drastically increased their incomes per capita in the next centuries.

The late 20th century, with its global economy of a few very wealthy nations, and many very poor nations, led to the study of how the transition from subsistence and resource-based economies, to production and consumption based-economies occurred, leading to the field of Development economics.

[edit] Measuring growth

The real GDP per capita of an economy is often used as an indicator of the average standard of living of individuals in that country, and economic growth is therefore often seen as indicating an increase in the average standard of living.

However, there are some problems in using growth in GDP per capita to measure general well being.

  • GDP per capita does not provide any information relevant to the distribution of income in a country.
  • GDP per capita does not take into account negative externalities from pollution consequent to economic growth. Thus, the amount of growth may be overstated once we take pollution into account.
  • GDP per capita does not take into account positive externalities that may result from services such as education and health.
  • GDP per capita excludes the value of all the activities that take place outside of the market place (such as cost-free leisure activities like hiking).

Economist are well aware of these defeciencies in GDP, thus, it should always be viewed merely as an indicator and not an absolute scale. Economist have developed mathematical tools to measure inequality, such as the Gini Coefficient. There are also alternate ways of measurement that consider the negative externalities that may result from pollution and resource depletion (see Green Gross Domestic Product.)

The flaws of GDP may be important when studing public policy, however, for the purposes of economic growth in the long run it tends to be a very good indicator. There is no other indicator in economics which is as universal or as widely accepted as the GDP.

Image:Gdp accumulated change.png
GDP increase since 1990 for the IMF "advanced economies".
Economic growth is exponential, where the exponent is determined by the PPP annual GDP growth rate. Thus, the differences in the annual growth from country A to country B will multiply up over the years. For example, a growth rate of 5% seems similar to 3%, but over two decades, the first economy would have grown by 165%, the second only by 80%.

[edit] Theories of economic growth

The short-run variation of economic growth is termed the business cycle, and almost all economies experience periodic recessions. Explaining and preventing these fluctuations is one of the main focuses of macroeconomics.

A statistical relationship called Okun's law relates the growth rate of an economy to the level of unemployment. On a Keynesian view, growth varies because of changes in aggregate demand, causing firms to produce more or less goods for sale and hence altering the size of the economy. The contrasting real business cycle model suggests that in the short run growth depends on a series of shocks to the productivity of the economy, e.g. an oil price rise making the economy generally less productive and reducing growth.

The long-run path of economic growth is one of the central questions of economics; in spite of the 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 28 years, whilst a growth rate of 8% per annum (experienced by some East Asian Tigers) will lead to a doubling of GDP within 9 years.

The neo-classical growth model, developed by Robert Solow 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 neo-classical 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 that allows production with fewer resources, but the model assumes technological progress, "exogenizing" technology from the model.

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 focussed on what increases human capital (e.g. education) or technological change (e.g. innovation).

There is common misconception that the positive correlation between high income and cold climate is causal, when in fact it is a by-product of history. Former colonies have inherited corrupt governments and geo-political boundaries (set by the colonizers) that are not properly placed regarding the geographical locations of different ethnic groups; this creates internal disputes and conflicts. Colonies in temperate climate zones as Australia and USA did not inherit exploitative governments since Europeans were able to inhabit these territories and set up governments that mirrored those in Europe. Thus, we observe a correlation between high incomes and average temperatures but the correlation is, again, not casual and a mere reflection of the product of colonization.

Jared Diamond attempts to explain, in his book Guns, Germs and Steel, why it was that some groups were able to colonize others. He argues that Eurasia was much more advanced because it had a larger surface area that had a common climate (oriented from east to west as opposed to America which is oriented from North to South,) they had more domesticable animals. This advantages in size and agro-technologies translated in the long run into advantages that allowed them to become militarily stronger than other groups.

[edit] Literature

  • Barro, Robert J. 1997. Determinants of Economic Growth: A Cross-Country Empirical Study. MIT Press: Cambridge, MA.
  • Georg Erber, Harald Hagemann, Growth, Structural Change, and Employment, in: Frontiers of Economics, Ed. Klaus F. Zimmermann, Springer-Verlag, Berlin – Heidelberg – New York, 2002, 269-310.
  • Foley, Duncan K. 1999. Growth and Distribution. Harvard University Press: Cambridge, MA.
  • Jones, Charles I. 2002. Introduction to Economic Growth. 2nd ed. W. W. Norton & Company: New York, N.Y.

[edit] See also

[edit] External links

bg:Икономически растеж cs:Hospodářský růst de:Wirtschaftswachstum es:Crecimiento económico eo:Ekonomia kresko fa:رشد اقتصادی fr:Croissance économique he:צמיחה כלכלית hr:Ekonomski rast nl:Economische groei ja:経済成長 sh:Ekonomski rast fi:Talouskasvu zh:经济增长

Economic growth

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