Notes on Economic Growth
Economic Growth is a key macroeconomic goal and contributes significantly to improvement in the standard of living.
It is undesirable to be facing negative economic growth (recession) and low rates of economic growth as this suggests that the standard of living may be falling or hardly improving. Unemployment would also be rising.
Instead, high rates of sustainable and inclusive economic growth is ideal.
Be very familiar with terms like:
- Actual Economic Growth
This is an increase in actual output produced by the economy over a year. This is what we are referring to most of the time when we say economic growth and when you read about it in the news.
The economic growth rate is calculated as the percentage increase in real national output or Real Gross Domestic Product
Economic Growth Rate (t) =
[RGDP (t) – RGDP (t–1) / RGDP (t)] × 100%
An increase in aggregate demand (AD), ceteris paribus, will usually lead to actual economic growth. (Link to components of the AD)
An increase in the short-run part of the Aggregate Supply (AS) due to favourable weather (agricultural based economy) or fall in the unit costs of production can also lead to actual economic growth.
Diagrammatic analysis will be covered in economics tuition classes. (AD AS and even on PPC diagram)
Developing economies such as China generally have higher economic growth than developed economies such as the United States, which are considered mature economies.
Sources of economic growth also differ from country to country due to the nature of their economy. For a large economy like the US, with its large domestic market, it is more dependent on Consumption for economic growth (about 70% of GDP) whilst a small economy like Singapore, with its small domestic market, is more dependent on Exports (about 200% of GDP). It can be said that the US is more dependent on domestic demand while Singapore is more dependent on External Demand.
Actual Economic Growth can lead to a rise in RGDP per capita provided it exceeds population growth rates. Thus, we aim to achieve high economic growth rates to ensure that Standard of Living is improving.
Recession or Economic Downturn = RGDP falling
Economic Slowdown = RGDP increasing but at a lower rate
Diagrammatic analysis will be covered in class.
- Potential Economic Growth
Potential economic growth is an increase in the full-employment level of national output or RGDP which may also be termed as potential output. This basically means that the economy can potentially produce more goods and services.
This occurs when the long-run aggregate supply (LRAS) increases or the vertical section of the AS curve shifts rightwards. This could be due to an increase in the productive capacity of the economy (like the Production Possibility Curve shifting outwards). Therefore, the same factors that shift PPC outwards will do the same to the LRAS.
However, the increase in LRAS can also be due to an increase in productive efficiency of the economy, which could have arisen from a decline of frictional and structural unemployment as well as being exposed to greater competition. Do note that Full Employment does not mean Zero Unemployment.
Potential economic growth enables higher FUTURE standard of living.
Diagrammatic analysis will be covered in class.
Question: What can enable high economic growth?
We will cover this in class!
- Sustained Economic Growth
Sustained Economic Growth is achieved when the RGDP can continuously increase and without causing high rates of inflation. For this to occur, both actual and potential economic growth is needed. Without LRAS increasing, the economy cannot continue to grow. To ensure the economic growth will be accompanied by price stability, both the AD and AS should be increasing in tandem (and not one increasing far greater than the other).
Diagrammatic analysis will be covered in class.
- Sustainable Economic Growth
Sustainable economic growth refers to sustained economic growth that occurs in a manner that does not come at the expense of the future generations. The idea is that the needs of the present generation are met without causing a decline in the Standard of Living for future generations.
Aside from the conditions needed to achieve sustained economic growth, protection of the environment (natural capital), conservation and replenishment of resources as well as a sustainable government budget are needed to achieve sustainable economic growth.
A. Conservation, Replenishment and Development of Resources
As many resources are non-renewable such as fossil fuels, over-exploitation of resources will result in limited resources being available for future use which will hinder future economic growth. When there is over-fishing and intensive agricultural practices, marine life and soil biomes are also not allowed to replenish itself. This will harm the productive capacity and standard of living in the long term. Therefore, there is a need to conserve and replenish resources to achieve sustainability.
There is also a need to develop new sources of energy such as solar and nuclear power. As these sources of energy are renewable, they are necessary for achieving sustainable economic growth.
B. Protection of the Environment
Economic growth may lead to an increase in the amount of negative externalities in production as well as in consumption such as carbon emissions which will result in a more polluted environment. Think global warming and its problems such as climate change. In 2022, extreme weathers were experienced in various parts of the world. Heat waves as well as torrential rainfall and floods. All these damage agricultural output. As a result, food shortages and food security is a rising global concern. Will future generations have enough to eat? The unsustainable economic growth experienced in past decades has started to cause all these problems.
An increasingly polluted environment will also lead to a less healthy and hence less productive labour force. A fall in labour productivity in the economy will lead to a rise in the cost of production in the economy resulting in a decrease in the aggregate supply and hence lower economic growth. In addition, an increasingly polluted environment will lead to a shorter life expectancy which will lead to a decrease in the size of the labour force. A decrease in the quantity of labour in the economy will lead to a decrease in the production capacity of the economy resulting in a decrease in the long-run part of the aggregate supply and hence lower economic growth. This could be happening in certain parts of China, which some call “cancer cities”.
What can governments do to achieve sustainability? Recall the Market Failure topic! Lots of overlap here with concepts of common access resources and negative externalities right?
C. Sustainable Government Budget
It is possible for a lot of Government Spending and tax cuts to spur economic growth. But as the saying goes, “there is no free lunch”. When the government is in deficit , it will most likely require borrowing. There are governments in the world that have chalked up huge debts. The US and Japan are some examples. Ireland, Italy and Greece were also involved in the Eurozone Debt Crisis.
Essentially, debt has to be repaid. This would usually mean higher tax rates in the future, which would reduce disposable income and hence living standards. Higher tax rates could also mean lower rates of economic growth in the future. Hence, the current generations could be enjoying high rates of growth now but it comes at the expense of lower growth and lower standard of living for future generations.
- Inclusive Economic Growth
It is also important for the government to ensure that the benefits of economic growth are equitably distributed. Inclusive economic growth is one which is broad-based (as opposed to only a few sectors of the economy growing), with better economic opportunities for all. The majority should be experiencing higher real incomes and this will better ensure that higher living standards are actually achieved through economic growth.
Singapore now has among the highest RGDP per capita in the world. However, the Gini coefficient in Singapore, which is a measure of inequality of income distribution, has been above 0.4, which is considered high income inequality and one which can be dangerous to social stability.
How is it that economic growth may be non-inclusive in the first place? There are a few possible cases:
- The economic growth may be powered by exports whilst other sectors may be non-tradeable (and so don’t benefit from global demand) or face competition from imports.
- The economic growth may be capital and technology-driven. This will tend to benefit the high-skilled, who are already high income earners in the first place while the low-skilled may be displaced by technology.
- There may be a dual economy, for example, a high productivity manufacturing sector with a low productivity services sector.
In the case of Singapore, it is likely to be all the above reasons meshed together and probably further complicated by competition from foreign labour.
It should be noted that efforts to increase inclusivity may help further boost economic growth but they may also lower economic growth. More will be covered under macroeconomic policies.
Benefits of Economic Growth
Increase in the Standard of Living
- High economic growth can lead to an improvement in the standard of living.
- Think per capita. Goods and Services. Link to Mat SOL.
- Think about the ability to spend on healthcare and education. Link to non-Material SOL.
- Think higher employment / lower unemployment.
- Think government revenue that can be utilised to provide merit and public goods and even to redistribute to the lower income so as to reduce poverty and inequity.
- Economic growth may lead to a cleaner environment. When people’s income rises, they will become more concerned with a clean environment. This is because pollution will become a matter of social concern when economic growth has ensured the provision of basic necessities such as food and housing to the majority of the population. A cleaner environment will lead to a rise in the non-material standard of living.
Costs of Economic Growth
- Environmental Costs & Depletion of Resources
As explained above under Sustainable Economic Growth
- Worsening Income Inequity
Should this occur, then there may be social instability with implications on non-material standard of living. This may in turn deter investments, which would eventually result in derailment of economic growth.
Sometimes, certain government policies implemented to achieve economic growth may inadvertently worsen inequity. For example, reducing income taxes, which can spur consumption and investments. However, this could mean less government revenue available for redistribution and also if goods and services tax rates are implemented or increased to offset the fall in income tax revenue, then the lower income will be hurt more as it will affect them disproportionately. Income taxes tend to be progressive whilst consumption taxes are regressive.
- High Structural Unemployment
High economic growth arising from capital and technological adoption may lead to high structural unemployment. This is covered above under Inclusive economic growth.
- Balance of Trade Deficit
High economic growth may lead to a persistent balance of trade deficit. This is because high economic growth can lead to rapidly rising demand for imports and hence rising import expenditure. If export growth is low, high import growth may lead to a persistent balance of trade deficit (import expenditure exceeding exports revenue) resulting in various adverse consequences, which will be covered under the Balance of Trade / Balance of Payments topic. This has been the experience of Indonesia, whose economic growth tends to be powered by domestic consumption instead of exports. Demand for imported luxury goods will tend to increase with economic growth (and more than proportionately to income), causing worsening of the balance of trade.
- High Demand-pull Inflation
High economic growth may lead to high demand-pull inflation. High economic growth usually occurs due to a rapid increase in aggregate demand accompanied by the multiplier efefct. However, when aggregate demand rises rapidly, demand-pull inflation will be high if aggregate supply does not also rise rapidly. This is particularly true when the economy is already near the full-employment equilibrium. In such a case, the economy is not achieving sustained economic growth.
These are samples of what Mr Kelvin Hong provides to his students. To get your hands on all our concise notes, join our JC A Level & IB Economics Tuition programme today! School teachers who wish to use these materials can submit a request here. You may also wish to check out this sample of our Economics Definitions bank.