The main drivers of economic growthPosted on: November 2, 2022
by David Diaz
According to the International Monetary Fund’s (IMF) World Economic Outlook, as of July 2022, our global economy is facing “gloomy and more uncertain” times to come. A series of concurrent shocks have impacted a world economy still recovering from the pandemic; high inflation, constricted financial conditions, a slowdown in China’s economy, and significant impacts from the war in Ukraine, spell harsher conditions and greater risks for economies attempting to bounce back.
As a baseline, the IMF predicts that the global economy will slow from 6.1% last year to 3.2% this year. Controlling inflation, more-stringent financial policies, focused fiscal support and mitigating climate change are all cited as determinants in how the global economy will fare going forward. What else can help to drive to economic growth, and how can growth be made sustainable?
What is economic growth and why does it matter?
Economic growth is a term that refers to the growth of an economy, and is generally used to mean GDP growth. The GDP of a country is its gross domestic product, and is a measure of both the size and performance of its economy. It accounts for the total value of a country’s goods and services production over a given time period. For example, a country with an annual GDP growth rate of 6% has seen its economy increase by 6% over the past 12 months. Other measures of growth include gross national product (GNP) and gross national income (GNI), both are which are derived from GDP calculations. GDP takes into account the spending by governments, businesses, individual households and other entities.
Economic growth is one of the most-critical indicators of how healthy an economy is. Economic growth matters for a number of reasons:
- The long-term growth of a country’s economy has a positive impact on national income and employment rates, which in turn raise the standard of living
- It increases both the wealth of a country and its population
- Extra tax income from increased economic activity can be used by governments to develop the economy further and reduce budget deficits
- As populations grow, more money and further expansion is required to maintain living standards and wealth
- Economic growth can help to reduce poverty, though it cannot achieve this in isolation.
It’s the job of economists to analyse the statistics and datasets linked to the economy and use it to monitor trends, create models to forecast future developments, and provide advice to governments, businesses, the financial sector and other organisations.
Short-term growth and long-term growth
Growth rates vary dramatically from country to country – with developed countries generally observing slower economic growth than developing countries. The Intelligent Economist uses the example of the economies of India and America in 2016; while India’s growth rate was 7.1%, America’s was 1.6%, however their respective GDPs were $2.264 trillion and $18.57 trillion. Where a country is at in terms of its development provides much-needed context and, as such, it would be more appropriate to compare their growth rates at similar periods in their history.
Economic development is unsustainable when it increases vulnerability to crises. While short-term growth can be rapid, fluctuating in line with business cycles, sustainable long-term growth must balance macroeconomic concerns with our global future. It should also avoid the peaks and troughs witnessed during recessions.
The Organisation for Economic Cooperation and Development (OECD) is a forum where the governments of 37 democracies – including Canada, Korea, the Netherlands, Germany, Australia, Japan, Turkey, Spain, Mexico, the United States, and the United Kingdom – with market-based economies collaborate to develop policy standards to promote sustainable economic growth.
OECD countries account for:
- three-fifths of the world’s GDP
- three-quarters of world trade
- over 90% of global official development assistance
- half of the world’s energy consumption
- 18% of the world’s population.
Is economic growth the same as economic development?
While often used synonymously, economic growth does not mean the same as economic development.
Economic development refers to the process of alleviating populations from low standard of living, including supporting them to gain employment and appropriate shelter. Development is linked, and concerned, with sustainability: it seeks to meet the needs of the current population without negatively impacting future needs. This can include ensuring that natural resources are not depleted, minimising pollution and preventing the spread of diseases.
What are the main drivers of economic growth?
Economists generally isolate four main factors that drive growth:
- Human capital – Highly skilled, educated and well-trained workforces have a direct impact on economic performance; as well as ensuring quality output, work will be more efficient. Conversely, unskilled, under-utilised workforces will have the opposite effect, negatively impacting economies and raising unemployment levels.
- Physical capital – Infrastructure – such as factories, transport links and machinery – reduces costs, facilitates international trade, improves labour productivity and increases economic output and efficiency.
- Natural resources – These resources, such as oil, can boost production capacity and therefore economies. Proper utilisation of natural resources by governments is key to this, and is influenced by skills and knowledge, availability of labour and technology.
- Technology – Technological change and advancement significantly impacts economic growth, as new technologies have the potential to increase productivity and advance economies at lower costs.
Countries with advanced economies tend to have governments who focus on these four areas. As such, their economies perform markedly differently to countries with less-developed economies, where there may be an abundance of natural resources but where technological research and educating and upskilling workers is less of a focus. Factors affecting growth include: political instability; poor levels of education and health amongst a population; flight of capital; lack of infrastructure; and institutional frameworks.
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