Economic growth: Encyclopedia II - Economic growth - The Question of Growth

Economic growth - The Question of 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 increasing well-being. These include:

• expenditure to offset the adverse environmental effects of economic growth such as pollution. (These are called defensive expenditure.)
• economic 'bads' such as commuting costs.
• measurement of non-marketed output such as housework. (If an individual hires a cleaner instead of cleaning their house themselves, it adds to GDP. The time spent cleaning the house before was not counted as part of GDP, while it is counted now. The house may or may not be cleaner.)
• GDP doesn’t reflect the underground or parallel economy
• Doesn’t reflect DIY activities
• some good output may not be included in GDP e.g. parents doing childcare, friends helping with home improvements, do-it-yourself, and volunteer work.
• property income unrelated to production is excluded from GDP.
• inequality (the uneven distribution of income). (If we assume diminishing marginal utility of income, extra income yields less utility for those with already-high incomes than for those with low incomes, so an increase in GDP may increase utility by different amounts depending upon individual's place in distribution. In particular, economic growth which yields savings not passed down to customers may disproportionately benefit stockholders, who are likely already wealthy)

Other measures of national income, such as the Index of Sustainable Economic Welfare or the Genuine Progress Indicator, have been developed in an attempt to give a more complete picture of the level of well-being, but there is no consensus as to which, if any, is a better measure than GDP. GDP still remains by far the most often-used measure, especially since, all else equal, a rise in real GDP is correlated with an increase in the availability of jobs, which are necessary to most individuals' survival.

The short-run variation of economic growth is termed the business cycle, and almost all economies experience periodic recessions. The cycle can be a misnomer as the fluctuations are not always regular. Explaining these fluctuations is one of the main focuses of macroeconomics. There are different schools of thought as to the causes of recessions but some consensus- see Keynesianism, Monetarism, New classical economics and New Keynesian economics. Oil shocks, war and harvest failure are obvious causes of recession. Short-run variation in growth has generally dampened in higher income countries since the early 90s and this has been attributed, in part, to better macroeconomic management.

The long-run path of economic growth is one of the central questions of economics; despite the caveats given above, 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. A growth rate of 2.5% per annum will lead to a doubling of GDP within 30 years, whilst a growth rate of 8% per annum (experienced by some East Asian Tigers) will lead to a doubling of GDP within 10 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).

Analysis of recent economic success shows a close correlation between growth and climate, though the actual linkage between the two--and possible causal mechanisms--remains a topic of hot debate. Cold states like Sweden are much more successful economically than warm countries like Nigeria. In early human history, economic as well as cultural development was concentrated in warmer parts of the world, like Egypt. Today, however, cold, Northern states have much higher GDP per capita compared to the hot, tropical states. This aspect of economics (economic geography)--and its influence on human migration and political structures--was extensively studied by Ellsworth Huntington, a professor of Economics at Yale University in the early 20th century.

Adapted from the Wikipedia article "The Question of Growth", under the G.N U Free Docmentation License. Please also see http://en.wikipedia.org/wiki