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 might cause GDP to rise?
GDP is prone to inflation because it is dependent on the monetary worth of goods and services. Rising prices tend to boost a country’s GDP, but this does not always represent changes in the number or quality of goods and services provided.
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 is the primary cause of GDP fluctuations in the short term?
A rise in aggregate demand drives economic growth in the short run (AD). If the economy has spare capacity, an increase in AD will result in a higher level of real GDP.
Factors which affect AD
- Lower interest rates – Lower interest rates lower borrowing costs, which encourages consumers to spend and businesses to invest. Lower interest rates cut mortgage payments, increasing consumers’ discretionary income.
- Wages have been raised. Increased real wages enhance disposable income, which encourages consumers to spend.
- Greater government expenditure (G), such as government investments in new roads or increased spending on welfare payments, both of which enhance disposable income.
- Devaluation. A decrease in the value of the currency rate (for example, the Pound Sterling) lowers the cost of exports and increases the volume of exports (X). Imports become more expensive as a result of depreciation, lowering the quantity of imports and making domestic goods more appealing.
- Confidence. Households with higher consumer confidence are more likely to spend, either by depleting their savings or taking out more personal credit. It encourages spending by allowing increased spending (C) (C).
- Reduced taxation. Consumers’ disposable income will increase as a result of lower income taxes, which will lead to increased expenditure (C).
- House prices are increasing. A rise in housing prices results in a positive wealth effect. Homeowners who see their property value rise will be more willing to spend (remortgaging house if necessary)
- Financial stability is important. Firms will be more eager to invest if there is financial stability and banks are willing to lend, and investment will enhance aggregate demand.
Long-term economic growth
This necessitates an increase in both AD and long-run aggregate supply (productive capacity).
- Capital increase. Investment in new manufacturing or infrastructure, such as roads and telephones, are examples.
- Increased labor productivity as a result of improved education and training, as well as enhanced technology.
- New raw materials are being discovered. Finding oil reserves, for example, will boost national output.
- Microcomputers and the internet, for example, have both led to higher economic growth through improving capital and labor productivity. New technology, such as artificial intelligence (AI), which allows robots to take the place of human workers, may be the source of future economic growth.
Other factors affecting economic growth
- Stability in the economy and politics. Stability is vital for convincing businesses that investing in capacity expansion is a sensible decision. When there is a surge in uncertainty, confidence tends to diminish, which can cause businesses to postpone investment.
- Inflation is low. Low inflation creates a favorable environment for business investment. Volatility is exacerbated by high inflation.
Periods of economic growth in UK
The United Kingdom saw substantial economic expansion in the 1980s, owing to a number of factors.
- Reduced income taxes increase disposable income, which leads to increased expenditure and, in turn, stimulates corporate investment.
- House prices rose, resulting in a positive wealth effect, equity withdrawal, and increased consumer spending.
In any economy, what are the three main sources of economic growth?
Increases in labor, capital, and the efficiency with which these two components are utilised are the three primary sources of economic growth.
What are the four economic growth factors?
Factors of production are the materials and services that businesses require to create goods and services. They are able to benefit as a result of this. The concept of these components may be traced back to neoclassical economics, which combined historic economic theories with other concepts such as labor. Land, labor, capital, and entrepreneurship are the four components of production, as stated previously. The factors of production are defined by the Federal Reserve Bank of St Louis as follows:
What impact does GDP have on the economy?
- It indicates the total value of all commodities and services produced inside a country’s borders over a given time period.
- Economists can use GDP to evaluate if a country’s economy is expanding or contracting.
- GDP can be used by investors to make investment decisions; a weak economy means lower earnings and stock values.
When real GDP rises, what happens?
An increase in nominal GDP may simply indicate that prices have risen, whereas an increase in real GDP indicates that output has risen. The GDP deflator is a price index that measures the average price of goods and services generated in all sectors of a country’s economy over time.
What factors influence short-term growth?
Economic growth is defined as an increase in real GDP, or the value of goods and services generated in a given country.
The annual percentage rise in real GDP is the rate of economic growth. There are various elements that influence economic growth, but it is useful to categorize them as follows:
Demand side factors Aggregate Demand (AD)
As a result, higher AD and economic growth can be achieved through increasing consumption, investment, government spending, or exports.
- Rates of interest. Lower interest rates would make borrowing less expensive, enticing businesses to invest and consumers to spend. Mortgage holders will have cheaper monthly mortgage payments, resulting in greater disposable cash. However, we experienced a period of exceptionally low interest rates from 2009 to 2016, but economic development remained sluggish due to poor confidence and hesitant bank lending.
- Consumer trust is high. Consumer and business confidence are critical indicators of economic progress. Consumers will be motivated to borrow and spend if they are optimistic about the future. They will conserve and cut spending if they are pessimistic.
- Prices of assets. A positive wealth effect is created by rising housing prices. People can re-mortgage their homes to take advantage of rising property values, which encourages additional consumer spending. Because there are so many homeowners in the UK, house prices are a significant factor.
- Wages that are realistic. The United Kingdom has recently suffered a period of declining real wages. Inflation has outpaced nominal salaries, resulting in a drop in real incomes. In this situation, consumers will be forced to cut back on their spending, particularly on luxury things.
- The exchange rate’s value. Exports would become more competitive and imports would become more expensive if the Pound fell in value. This would assist to boost domestic demand for goods and services. A depreciation may generate inflation in the long run, but it can increase GDP in the short term.
- The banking industry. The financial crisis of 2008 shown how powerful the banking sector can be in influencing investment and growth. If banks lose money and refuse to lend, it can be exceedingly difficult for businesses and consumers to get loans, resulting in a drop in investment.
Factors that determine long-run economic growth
In the long run, factors that influence the increase of Long Run Aggregate Supply determine economic growth (LRAS). A rise in AD will be inflationary if there is no increase in LRAS.
Classical view
An increase in LRAS and AD leads to an increase in economic growth without inflation, as shown in this graph.
- Infrastructure levels. Firms can cut costs and expand productivity by investing in roads, transportation, and communication. It can be difficult for businesses to compete in foreign markets if they lack the requisite infrastructure. Infrastructure is frequently cited as a factor holding back some developing economies.
- Human capital is a term that refers to the value of The productivity of workers is referred to as human capital. Levels of education, training, and motivation will decide this. Increased labor productivity can assist businesses in adopting more complex manufacturing methods and being more efficient.
- Technology advancement. Long-term, new technology development is a critical aspect in enabling increased productivity and economic growth.
- The labor market’s sturdiness. Firms will find it easier to hire the workers they require if labor markets are flexible. This will make it easy to expand. Markets that are overly regulated may deter businesses from recruiting in the first place.
Productivity is defined as production per worker, and it has a significant impact on the long-term trend rate of economic growth. Technology, levels of new technology investment, and labor force skills will all influence productivity.
Since the 2007 recession, productivity growth has slowed, resulting in slower economic development.
Other factors that can affect growth in the short term
- Prices of commodities. A surge in commodity prices, such as oil costs, can send growth into a tailspin. As a result, the SRAS shifts to the left, resulting in higher inflation and slower growth.
- Instability in politics. Political unrest can have a negative impact on economic progress.
- Weather. The unusually chilly December of 2010 in the United Kingdom resulted in a surprising drop in GDP.
Examples of Economic Growth
A graph depicting the UK’s quarterly economic growth. A recession occurred in 1981, 1991, and 2008.
- It was aided by technology advancements, such as rapid advancements in computers, the internet, and mobile phones, which improved productivity growth.
- Inflationary atmosphere that is stable. In 1997, the Bank of England was given authority of monetary policy.
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.