Economic development and growth are impacted by four variables, according to economists: human resources, physical capital, natural resources, and technology. Governments in highly developed countries place a strong emphasis on these issues. Less-developed countries, especially those with abundant natural resources, will fall behind if they do not push technological development and increase their workers’ skills and education.
What are the four variables that influence GDP?
Personal consumption, business investment, government spending, and net exports are the four components of GDP domestic product. 1 This reveals what a country excels at producing. The gross domestic product (GDP) is the overall economic output of a country for a given year. It’s the same as how much money is spent in that economy.
What causes the GDP to rise?
In general, there are two basic causes of economic growth: increase in workforce size and increase in worker productivity (output per hour worked). Both can expand the economy’s overall size, but only substantial productivity growth can boost per capita GDP and income.
What factors influence a country’s GDP?
Defined Gross Domestic Product (GDP) Personal consumption, private investment, government spending, and exports are all factors that go into calculating a country’s GDP (minus imports).
What factors directly influence GDP?
Gross domestic product (GDP) is a metric that represents an economy’s overall production by summing total consumption, investment, government spending, and net exports. As a result, GDP is regarded as a good approximation of income for a whole economy during a certain time period.
What causes GDP to rise or fall?
The external balance of trade is the most essential of all the components that make up a country’s GDP. When the total value of products and services sold by local producers to foreign countries surpasses the total value of foreign goods and services purchased by domestic consumers, a country’s GDP rises. A country is said to have a trade surplus when this happens.
How can you boost GDP growth?
- AD stands for aggregate demand (consumer spending, investment levels, government spending, exports-imports)
- AS stands for aggregate supply (Productive capacity, the efficiency of economy, labour productivity)
To increase economic growth
1. An increase in total demand
- Lower interest rates lower borrowing costs and boost consumer spending and investment.
- Increased real wages when nominal salaries rise faster than inflation, consumers have more money to spend.
- Depreciation reduces the cost of exports while raising the cost of imports, increasing domestic demand.
- Growing wealth, such as rising house values, encourages people to spend more (since they are more confident and can refinance their home).
This represents a rise in total supply (productive capacity). This can happen as a result of:
- In the nineteenth century, new technologies such as steam power and telegrams aided productivity. In the twenty-first century, the internet, artificial intelligence, and computers are all helping to boost productivity.
- Workers become more productive when new management approaches, such as better industrial relations, are introduced.
- Increased net migration, with a particular emphasis on workers with in-demand skills (e.g. builders, fruit pickers)
- Infrastructure improvements, greater education spending, and other public-sector investments are examples of public-sector investment.
To what extent can the government increase economic growth?
A government can use demand-side and supply-side policies to try to influence the rate of economic growth.
- Cutting taxes to raise disposable income and encourage spending is known as expansionary fiscal policy. Lower taxes, on the other hand, will increase the budget deficit and lead to more borrowing. When there is a drop in consumer expenditure, an expansionary fiscal policy is most appropriate.
- Cutting interest rates can promote domestic demand. Expansionary monetary policy (currently usually set by an independent Central Bank).
- Stability. The government’s primary job is to maintain economic and political stability, which allows for normal economic activity to occur. Uncertainty and political polarization can deter investment and growth.
- Infrastructure investment, such as new roads, railway lines, and broadband internet, boosts productivity and lowers traffic congestion.
Factors beyond the government’s influence
- It is difficult for the government to influence the rate of technical innovation because it tends to come from the private sector.
- The private sector is in charge of labor relations and employee motivation. At best, the government has a minimal impact on employee morale and motivation.
- Entrepreneurs are primarily self-motivated when it comes to starting a firm. Government restrictions and tax rates can have an impact on a business owner’s willingness to take risks.
- The amount of money saved has an impact on growth (e.g. see Harrod-Domar model) Higher savings enable higher investment, yet influencing savings might be difficult for the government.
- Willingness to put forth the effort. The vanquished countries of Germany and Japan had fast economic development in the postwar period, indicating a desire to rebuild after the war. The UK economy was less dynamic, which could be due to different views toward employment and a willingness to try new things.
- Any economy is influenced significantly by global growth. It is extremely difficult for a single economy to avoid the costs of a global recession. The credit crunch of 2009, for example, had a detrimental impact on economic development in OECD countries.
In 2009, the United States, France, and the United Kingdom all went into recession. The greater recovery in the United States, on the other hand, could be attributed to different governmental measures. 2009/10 fiscal policy was expansionary, and monetary policy was looser.
Governments frequently overestimate their ability to boost productivity growth. Without government intervention, the private sector drives the majority of technological advancement. Supply-side measures can help boost efficiency to some level, but how much they can boost growth rates is questionable.
For example, after the 1980s supply-side measures, the government looked for a supply-side miracle that would allow for a significantly quicker pace of economic growth. The Lawson boom of the 1980s, however, proved unsustainable, and the UK’s growth rate stayed relatively constant at roughly 2.5 percent. Supply-side initiatives, at the very least, will take a long time to implement; for example, improving labor productivity through education and training will take many years.
There is far more scope for the government to increase growth rates in developing economies with significant infrastructure failures and a lack of basic amenities.
The potential for higher growth rates is greatly increased by providing basic levels of education and infrastructure.
The private sector is responsible for the majority of productivity increases. With a few exceptions, private companies are responsible for the majority of technical advancements. The great majority of productivity gains in the UK is due to new technologies developed by the private sector. I doubt the government’s ability to invest in new technologies to enhance productivity growth at this rate. (Though it is possible especially in times of conflict)
Economic growth in the UK
The UK economy has risen at a rate of 2.5 percent each year on average since 1945. Most economists believe that the UK’s productive capacity can grow at a rate of roughly 2.5 percent per year on average. The underlying trend rate is also known as the ‘trend rate of growth.’
Even when the government pursued supply-side reforms, they were largely ineffective in changing the long-run trend rate. (For example, in the 1980s, supply-side policies had minimal effect on the long-run trend rate.)
The graph below demonstrates how, since 2008, actual GDP has fallen below the trend rate. Because of the recession and a considerable drop in aggregate demand, this happened.
- Improved private-sector technology that allows for increased labor productivity (e.g. development of computers enables greater productivity)
- Infrastructure investment, such as the construction of new roads and train lines. The government is mostly responsible for this.
What causes a drop in real GDP?
Shifts in demand, rising interest rates, government expenditure cuts, and other factors can cause a country’s real GDP to fall. It’s critical for you to understand how this figure changes over time as a business owner so you can alter your sales methods accordingly.
Is a higher or lower GDP preferable?
Gross domestic product (GDP) has traditionally been used by economists to gauge economic success. If GDP is increasing, the economy is doing well and the country is progressing. On the other side, if GDP declines, the economy may be in jeopardy, and the country may be losing ground.
What causes the economy to grow slowly?
Dietrich Vollrath writes that growth has slowed as a result of decreasing fertility and a shift in spending away from goods and toward services.
We’re used to assessing the health of our economy by looking at the GDP growth rate. That’s why the recent slowdown in growth appears to be so concerning. In the United States, GDP growth in 2019 was 2.3 percent, which means it has been nineteen years since the economy grew at 4%, and nearly as long since it grew at 3%. The situation in the United Kingdom is similar, as it has been fifteen years since the country’s growth rate reached 3%. In the Eurozone as a whole, the last time growth approached 4% was in 2000. These slowdowns in industrialized economies predate the financial crisis, which raises the obvious question of what went wrong with the economy and how to fix it.
However, the slowdown we’re seeing isn’t anything we can or would want to address because the lag was never caused by something going wrong. Instead, as I demonstrate in my new book, the slowdown is the result of things that went well.
From a simple accounting standpoint, slower growth is due to two key factors: a decline in fertility during the twentieth century, and a shift in our expenditures away from goods and toward services. Both of these explanations can be linked to financial success.
For decades, the decline in fertility had a considerable impact on economic growth, particularly in the United States. During the middle of the twentieth century, the baby boom unleashed a one-time surge of human capital on the economy. The percentage of workers to population increased dramatically when those new workers entered the workforce, as indicated by the drop in the youth dependence ratio between 1960 and 1980. (see Figure 1). This, combined with the baby boomers’ comparatively high educational attainment compared to previous generations, offered a significant boost to the growth rate, which increased by roughly 1.25 percentage points in 1990 compared to immediately after WWII.
Figure 1 Age dependency ratios in the US
The growth rate slowed as the wave of human capital faded. The old age dependence ratio began to climb in the early 2000s (see Figure 1), as a natural result of the decline in youth dependency in the 1960s and 1970s. As workers retired from the workforce and as they continue to do so the aggregate economy’s growth rate slowed. The 1.25 percentage point boost experienced in the twentieth century vanished in the twenty-first, accounting for the majority of the slowdown in the United States.
But why should we consider these shifts in demographics to be a success? Several successes contributed to the reduction in fertility after the baby boom, which explains the shifts. People’s willingness to marriage was pushed back as college education became more widely available. Numerous women were able to defer marriage as a result of the opening up of many professions to women, as well as increases in total salaries. Finally, breakthroughs in contraception technology allowed women to take advantage of newly available educational and professional prospects. Family decisions taken decades ago in reaction to growing living conditions and the development of women’s rights have resulted in today’s growth slowdown.
The move from products to services, the second reason of the slowdown, was likewise fueled by success. We have become highly efficient at creating products such as clothing, food, furniture, and computers over the last century. As a result, the cost of those things has steadily decreased in comparison to the cost of services. We could have used the savings to buy even more commodities than we did, but instead we used them to pay for more services like education, healthcare, and travel. As a result, our spending have shifted away from things and toward services (see Figure 2). We still consume more products than before; it’s just that they’ve become so inexpensive that their share of overall spending has decreased in comparison to services.
Figure 2 Expenditure shares in the US
However, this had an impact on total economic growth. Services have a slower rate of productivity growth than products. That wasn’t due to a service failure in recent years. In the 1960s, economist William Baumol noticed that it was an intrinsic quality. You’d grumble about slow service and lack of attention if a restaurant or a business tried to operate with half of its typical employees. In comparison, you’d never know if a company built an excellent laptop with half the labor. This makes service productivity growth more difficult than it is for products. As we transferred our spending to services, our overall productivity growth was certain to slow. This certainly cut another 0.2 to 0.25 percentage points off the growth rate between the middle of the twentieth century and today. But keep in mind that this was only possible because of the productivity gain we saw in the first place, which was a success.
The conventional suspects are unable to explain the economic slowdown in light of the accomplishments in demographic and spending trends. Tax rates plummeted just as the slowdown began, and evidence from a variety of states and industries demonstrates that, if anything, more regulation is linked to faster growth, not slower growth. Although trade with China has increased in the previous two decades, research suggests that it has had little impact on overall economic growth, despite local regions and industries experiencing booms and busts. Measures of the mark-up of price over cost climbed across the economy, although this did not slow development. Because we created more valuable items, the shift of activity to high-margin industries kept economic growth rates from falling even more.
If you’re still not convinced that success is causing the economic slowdown, consider what you’d give up to get growth back to 4%. We could obliterate 50% of our possessions, including automobiles, couches, televisions, laptop computers, houses, trampolines, and so on. As we hurried to replace everything, we’d see a major shift in expenditure toward products, and productivity growth would skyrocket. Alternatively, we might pull back contraception rights and women’s involvement in the workforce in order to kickstart a fresh baby boom. Wait twenty years, and the economy will be flooded with new human capital. Would either of those be worthwhile merely to see growth return to 4%, albeit not until 2040? If the response is “no,” we can deduce that the growth slowdown occurred as a result of things that went well, things we would not abandon.
The premise that success causes a slowing in growth does not mean we should be complacent about the economy or that issues like inequality, market dominance, regulation, and trade are unimportant. Rather, the slowing shows that we have the ability to address those problems. We should not lose the opportunity to fix the problems in our economy by worrying about the growth lost as a result of the things that went well.
- This article originally appeared on LSE Business Review and is based on the author’s book, Fully Grown: Why a Stagnant Economy Is a Sign of Success, published by University of Chicago Press (2020).
What causes economic expansion?
- Consumer spending and company investment are generally the driving forces behind economic growth.
- Tax cuts and rebates are used to give money back to consumers and encourage them to spend more.
- Deregulation loosens the laws that firms must follow and is credited with spurring growth, but it can also lead to excessive risk-taking.
- Infrastructure funding is intended to boost productivity by allowing firms to function more effectively and create construction jobs.