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Economic growth is the increase in the market value of the goods and services produced by an economy over time. It is conventionally measured as the percent rate of increase in real gross domestic product, or real GDP. Of more importance is the growth of the ratio of GDP to population (GDP per capita), which is also called per capita income. An increase in growth caused by more efficient use of inputs is referred to as intensive growth. GDP growth caused only by increases in inputs such as capital, population or territory is called extensive growth.
Growth is usually calculated in real terms – i.e., inflation-adjusted terms – to eliminate the distorting effect of inflation on the price of goods produced. Measurement of economic growth uses national income accounting. In economics, "economic growth" or "economic growth theory" typically refers to growth of potential output, i.e., production at "full employment". As an area of study, economic growth is generally distinguished from development economics. The former is primarily the study of how countries can advance their economies. The latter is the study of the economic aspects of the development process in low-income countries (See also: Economic development).
Since economic growth is measured as the annual percent change of gross domestic product (GDP), it has all the advantages and drawbacks of that measure. For example, GDP only measures the market economy, which tends to overstate growth during the change over from a farming economy with household production. An adjustment was made for food grown on and consumed on farms, but no correction was made for other household production. Also, there is no allowance in GDP calculations for depletion of natural resources.
The U.S. Commerce Department's Bureau of Economic Analysis (BEA) provides economic statistics, including GDP. The BEA website conatins links to various documents that explain the concepts and methodology of national income and products accounts and GDP as well as historical tables.
Increases in productivity have historically been the most important source of real per capita economic growth. Increases in productivity lower the cost of goods, which is called a shift in supply. Over the 20th century the real price of many goods fell by over 90%. Lower prices create an increase in aggregated demand, but demand for individual goods and services is subject to diminishing marginal utility. (See also:Salter cycle)
Economic growth has traditionally been attributed to the accumulation of human and physical capital, and increased productivity arising from technological innovation.
Before industrialization, technological progress resulted in an increase in population, which was kept in check by food supply and other resources, which acted to limit per capita income, a condition known as the Malthusian trap. The rapid economic growth that occurred during the Industrial Revolution was remarkable because it was in excess of population growth, providing an escape from the Malthusian trap. Countries that industrialized eventually saw their population growth slow, a condition called demographic transition.
Increases in productivity are the major factor responsible for per capita economic growth – this has been especially evident since the mid-19th century. Most of the economic growth in the 20th century was due to reduced inputs of labor, materials, energy, and land per unit of economic output (less input per widget). The balance of growth has come from using more inputs overall because of the growth in output (more widgets or alternately more value added), including new kinds of goods and services (innovations).
During the Industrial Revolution, mechanization began to replace hand methods in manufacturing, and new processes streamlined production of chemicals, iron, steel, and other products. Machine tools made the economical production of metal parts possible, so that parts could be interchangeable. See: Interchangeable parts.
During the Second Industrial Revolution, a major factor of productivity growth was the substitution of inaminate power for human and animal labor. Also there was a great increase power as steam powered electricity generation and internal combustion supplanted limited wind and water power. Since that replacement, the great expansion of total power was driven by continuous improvements in energy conversion efficiency. Other major historical sources of productivity were automation, transportation infrastructures (canals, railroads, and highways), new materials (steel) and power, which includes steam and internal combustion engines and electricity. Other productivity improvements included mechanized agriculture and scientific agriculture including chemical fertilizers and livestock and poultry management, and the Green Revolution. Interchangeable parts made with machine tools powered by electric motors evolved into mass production, which is universally used today.
Great sources of productivity improvement in the late 19th century were railroads, steam ships, horse-pulled reapers and combine harvesters, and steam-powered factories. The invention of processes for making cheap steel were important for many forms of mechanization and transportation. By the late 19th century both prices and weekly work hours fell because less labor, materials, and energy were required to produce and transport goods. However, real wages rose, allowing workers to improve their diet, buy consumer goods and afford better housing.
Mass production of the 1920s created overproduction, which was arguably one of several causes of the Great Depression of the 1930s. Following the Great Depression, economic growth resumed, aided in part by demand for entirely new goods and services, such as telephones, radio, television, automobiles, and household appliances, air conditioning, and commercial aviation (after 1950), creating enough new demand to stabilize the work week. The building of highway infrastructures also contributed to post World War II growth, as did capital investments in manufacturing and chemical industries. The post World War II economy also benefited from the discovery of vast amounts of oil around the world, particularly in the Middle East. By John W. Kendrick’s estimate, three-quarters of increase in U.S. per capita GDP from 1889 to 1957 was due to increased productivity.
Economic growth in Western nations slowed down after 1973. In contrast growth in Asia has been strong since then, starting with Japan and spreading to Korea, China, the Indian subcontinent and other parts of Asia. In 1957 South Korea had a lower per capita GDP than Ghana, and by 2008 it was 17 times as high as Ghana's. The Japanese economic growth has slackened considerably since the late 1980s.
Productivity in the United States grew at an increasing rate throughout the 19th century and was most rapid in the early to middle decades of the 20th century. US productivity growth spiked towards the end of the century in 1996–2004, due to an acceleration in the rate of technological innovation known as Moore's law.
Economic growth in the U.S. and other developed countries went through phases that affected growth through changes in the labor force participation rate and the relative sizes of economic sectors. The transition from an agricultural economy to manufacturing increased the size of the high output per hour, high productivity growth manufacturing sector while reducing the size of the lower output per hour, lower productivity growth agricultural sector. Eventually high productivity growth in manufacturing reduced the sector size as prices fell and employment shrank relative to other sectors. The service and government sectors, where output per hour and productivity growth is very low, saw increases in share of the economy and employment.
Demographic factors influence growth by changing the employment to population ratio and the labor force participation rate. Because of their spending patterns the working age population is an important source of aggregate demand. Other factors affecting economic growth include the quantity and quality of available natural resources, including land.
Industrialization creates a demographic transition in which birth rates decline and the average age of the population increases. Women with fewer children and better access market employment tend to join the labor force in higher percentages. There is a reduced demand for child labor and children spend more years in school.
|This section lends undue weight to certain ideas, incidents, or controversies. (July 2014)|
|This section may be unbalanced towards certain viewpoints. (July 2014)|
Inequality in wealth and income is negatively correlated with subsequent economic growth. A strong demand for redistribution will occur in societies where much of the population does not have access to productive resources. Rational voters have to internalize this dynamic problem of social choice." 2013 Economics Nobel prize winner Robert J. Shiller said that rising inequality in the United States and elsewhere is the most important problem.
Increasing inequality harms economic growth. High and persistent unemployment, in which inequality increases, has a negative effect on subsequent long-run economic growth. Unemployment can harm growth not only because it is a waste of resources, but also because it generates redistributive pressures and subsequent distortions, drives people to poverty, constrains liquidity limiting labor mobility, and erodes self-esteem promoting social dislocation, unrest and conflict. Policies aiming at controlling unemployment and in particular at reducing its inequality-associated effects support economic growth.
Theories popular from the 1970s to 2011 incorrectly stated that inequality had a positive effect on economic development. Savings by the wealthy, which increases with inequality, was thought to offset reduced consumer demand. The International Monetary Fund determined that the analysis based on comparing yearly equality figures to yearly growth rates was flawed and misleading because it takes several years for the effects of equality changes to manifest in economic growth changes.
The credit market imperfection approach, developed by Galor and Zeira (1993), demonstrates that inequality in the presence of credit market imperfections has a long lasting detrimental effect on human capital formation and economic development.
The political economy approach, developed by Alesina and Rodrik (1994) and Persson and Tabellini (1994), argues that inequality is harmful for economic development because inequality generates a pressure to adopt redistributive policies that have an adverse effect on investment and economic growth.
A study by Perotti (1996) examines of the channels through which inequality may affect economic growth. He shows that in accordance with the credit market imperfection approach, inequality is associated with lower level of human capital formation (education, experience, apprenticeship) and higher level of fertility, while lower level of human capital is associated with lower growth and lower levels of economic growth. In contrast, his examination of the political economy channel refutes the political economy mechanism. He demonstrates that inequality is associated with lower levels of taxation, while lower levels of taxation, contrary to the theories, are associated with lower level of economic growth
A 2011 note for the International Monetary Fund by Andrew G. Berg and Jonathan D. Ostry found a strong association between lower levels of inequality in developing countries and sustained periods of economic growth. Developing countries with high inequality have "succeeded in initiating growth at high rates for a few years" but "longer growth spells are robustly associated with more equality in the income distribution."
Disputing the claim of a Washington Post editorialist that "Western Europe’s recent history suggests that flat income distribution accompanies flat economic growth," journalist Timothy Noah, points out that redistribution policies in Europe do not seem correlated to economic problems of the late twenty-oughts. With the exception of Ireland, the countries at risk of default in 2011 (Greece, Italy, Spain, Portugal) were notable for their high Gini-measured levels of income inequality compared to other European countries. As measured by the Gini index, Greece as of 2008 had more income inequality than the economically healthy Germany.
Economists distinguish between short-run economic changes in production and long-run economic growth. Short-run variation in economic growth is termed the business cycle. The business cycle is made up of booms and drops in production that occur over a period of months or years. Generally, economists attribute the ups and downs in the business cycle to fluctuations in aggregate demand. In contrast, economic growth is concerned with the long-run trend in production due to structural causes such as technological growth and factor accumulation. The business cycle moves up and down, creating fluctuations around the long-run trend in economic growth.
In classical (Ricardian) economics, the theory of production and the theory of growth are based on the theory or law of variable proportions, whereby increasing either of the factors of production (labor or capital), while holding the other constant and assuming no technological change, will increase output, but at a diminishing rate that eventually will approach zero. These concepts have their origins in Thomas Malthus’s theorizing about agriculture. Malthus’s examples included the number of seeds harvested relative to the number of seeds planted (capital) on a plot of land and the size of the harvest from a plot of land versus the number of workers employed. See: Diminishing returns
The notion of growth as increased stocks of capital goods was codified as the Solow-Swan Growth Model, which involved a series of equations that showed the relationship between labor-time, capital goods, output, and investment. According to this view, the role of technological change became crucial, even more important than the accumulation of capital. This model, developed by Robert Solow and Trevor Swan 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 neoclassical 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 grow faster because each investment in capital produces a higher return than rich countries with ample capital. Third, because of diminishing returns to capital, economies eventually reach a point where any increase in capital no longer creates 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. In the long run, output per capita depends on the rate of saving, but the rate of output growth should be equal for any saving rate. In this model, the process by which countries continue growing despite the diminishing returns is "exogenous" and represents the creation of new technology that allows production with fewer resources. Technology improves, the steady state level of capital increases, and the country invests and grows. The data do not support some of this model's predictions, in particular, that all countries grow at the same rate in the long run, or that poorer countries should grow faster until they reach their steady state. Also, the data suggest the world has slowly increased its rate of growth.
Criticisms of the neo-classical growth model are that: 1) it does not account for differing rates of return for different capital investments, and 2) increasing capital creates a growing burden of depreciation. It is also noted that the economic life of capital assets has been declining.
The Salter cycle is one of economies of scale and learning-by-doing that lowers production costs. Lowered cost increases demand, resulting in another cycle of new capacity which leads to greater economies of scale and more learning by doing. The cycle repeats until markets become saturated due to diminishing marginal utility. 
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 focused on what increases human capital (e.g. education) or technological change (e.g. innovation).
There are also various heterodox theories that downplay or reject the neo-classical model and classical growth theory.
Energy economic theories emphasize the role of energy consumption and energy efficiency as important historical causes of economic growth. Increases in energy efficiency were an portion of the increase in Total factor productivity. Some of the most technologically important innovations in history involved increases in energy efficiency. These include the great improvements in efficiency of conversion of heat to work, the reuse of heat, the reduction in friction and the transmission of power, especially through electrification.
In the 1980s, the economists Daniel Khazzoom and Leonard Brookes independently put forward ideas about energy consumption and behavior that argue that increased energy efficiency paradoxically tends to lead to increased energy consumption. They cite this as a form of the Jevons paradox, where efficiency gains can increase consumption both locally by reducing energy cost compared to other inputs and broadly by promoting economic growth. In 1992, the US economist Harry Saunders dubbed this hypothesis the Khazzoom–Brookes postulate, and showed that it was true under neo-classical growth theory over a wide range of assumptions.
Unified growth theory was developed by Oded Galor and his co-authors to address the inability of endogenous growth theory to explain key empirical regularities in the growth processes of individual economies and the world economy as a whole. Endogenous growth theory was satisfied with accounting for empirical regularities in the growth process of developed economies over the last hundred years. As a consequence, it was not able to explain the qualitatively different empirical regularities that characterized the growth process over longer time horizons in both developed and less developed economies. Unified growth theories are endogenous growth theories that are consistent with the entire process of development, and in particular the transition from the epoch of Malthusian stagnation that had characterized most of the process of development to the contemporary era of sustained economic growth.
One popular theory in the 1940s was the Big Push, which suggested that countries needed to jump from one stage of development to another through a virtuous cycle, in which large investments in infrastructure and education coupled with private investments would move the economy to a more productive stage, breaking free from economic paradigms appropriate to a lower productivity stage.
Schumpeterian growth is an economic theory named after the 20th-century Austrian economist Joseph Schumpeter. Unlike other economic growth theories, his approach explains growth by innovation as a process of creative destruction that captures the dual nature of technological progress: in terms of creation, entrepreneurs introduce new products or processes in the hope that they will enjoy temporary monopoly-like profits as they capture markets. In doing so, they make old technologies or products obsolete.
This is the creative destruction referred to by Schumpeter, which could also be referred to as the annulment of previous technologies, which makes them obsolete, and "...destroys the rents generated by previous innovations." (Aghion 855) A major model that illustrates Schumpeterian growth is the Aghion-Howitt model.
According to Acemoğlu, Simon Johnson and James Robinson, the positive correlation between high income and cold climate is a by-product of history. Europeans adopted very different colonization policies in different colonies, with different associated institutions. In places where these colonizers faced high mortality rates (e.g., due to the presence of tropical diseases), they could not settle permanently, and they were thus more likely to establish extractive institutions, which persisted after independence; in places where they could settle permanently (e.g. those with temperate climates), they established institutions with this objective in mind and modeled them after those in their European homelands. In these 'neo-Europes' better institutions in turn produced better development outcomes. Thus, although other economists focus on the identity or type of legal system of the colonizers to explain institutions, these authors look at the environmental conditions in the colonies to explain institutions. For instance, former colonies have inherited corrupt governments and geo-political boundaries (set by the colonizers) that are not properly placed regarding the geographical locations of different ethnic groups, creating internal disputes and conflicts that hinder development. In another example, societies that emerged in colonies without solid native populations established better property rights and incentives for long-term investment than those where native populations were large.
One ubiquitous element of both theoretical and empirical analyses of economic growth is the role of human capital. The skills of the population enter into both neoclassical and endogenous growth models. The most commonly used measure of human capital is the level of school attainment in a country, building upon the data development of Robert Barro and Jong-Wha Lee. This measure of human capital, however, requires the strong assumption that what is learned in a year of schooling is the same across all countries. It also presumes that human capital is only developed in formal schooling, contrary to the extensive evidence that families, neighborhoods, peers, and health also contribute to the development of human capital. To measure human capital more accurately, Eric Hanushek and Dennis Kimko introduced measures of mathematics and science skills from international assessments into growth analysis. They found that quality of human capital was very significantly related to economic growth. This approach has been extended by a variety of authors, and the evidence indicates that economic growth is very closely related to the cognitive skills of the population.
Over long periods of time even small rates of growth, like a 2% annual increase, have large effects. For example, the United Kingdom experienced a 1.97% average annual increase in its inflation-adjusted GDP between 1830 and 2008. In 1830, the GDP was 41,373 million pounds. It grew to 1,330,088 million pounds by 2008. (Figures are adjusted for inflation and stated in 2005 values for the pound.) A growth rate that averaged 1.97% over 178 years resulted in a 32-fold increase in GDP by 2008.
The large impact of a relatively small growth rate over a long period of time is due to the power of exponential growth. A growth rate of 2.5% per annum leads to a doubling of the GDP within 29 years, whilst a growth rate of 8% per annum (an average exceeded by China between 2000 and 2010) leads to a doubling of GDP within 9 years. Thus, a small difference in economic growth rates between countries can result in very different standards of living for their populations if this small difference continues for many years.
Economic growth has the indirect potential to alleviate poverty, as a result of a simultaneous increase in employment opportunities and increase labour productivity. A study by researchers at the Overseas Development Institute (ODI) of 24 countries that experienced growth found that in 18 cases, poverty was alleviated. However, employment is no guarantee of escaping poverty, the International Labour Organisation (ILO) estimates that as many as 40% of workers as poor, not earning enough to keep their families above the $2 a day poverty line. For instance, in India most of the chronically poor are wage earners in formal employment, because their jobs are insecure and low paid and offer no chance to accumulate wealth to avoid risks; other countries found bigger benefits from focusing more on productivity improvement than on low-skilled work.
Increases in employment without increases in productivity leads to a rise in the number of working poor, which is why some experts are now promoting the creation of "quality" and not "quantity" in labour market policies. This approach does highlight how higher productivity has helped reduce poverty in East Asia, but the negative impact is beginning to show. In Vietnam, for example, employment growth has slowed while productivity growth has continued. Furthermore, productivity increases do not always lead to increased wages, as can be seen in the United States, where the gap between productivity and wages has been rising since the 1980s. The ODI study showed that other sectors were just as important in reducing unemployment, as manufacturing. The services sector is most effective at translating productivity growth into employment growth. Agriculture provides a safety net for jobs and economic buffer when other sectors are struggling. This study suggests a more nuanced understanding of economic growth and quality of life and poverty alleviation.
A number of arguments have been raised against economic growth.
Many earlier predictions of resource depletion, such as Thomas Malthus' 1798 predictions about approaching famines in Europe, The Population Bomb (1968), and the Simon–Ehrlich wager (1980)  have not materialized. Diminished production of most resources has not occurred so far, one reason being that advancements in technology and science have allowed some previously unavailable resources to be produced. In some cases, substitution of more abundant materials, such as plastics for cast metals, lowered growth of usage for some metals. In the case of the limited resource of land, famine was relieved firstly by the revolution in transportation caused by railroads and steam ships, and later by the Green Revolution and chemical fertilizers, especially the Haber process for ammonia synthesis.
In the case of minerals, lower grades of mineral resources are being extracted, requiring higher inputs of capital and energy for both extraction and processing. An example is natural gas from shale and other low permeability rock, which can be developed with much higher inputs of energy, capital, and materials than conventional gas in previous decades. Another example is offshore oil and gas, which has exponentially increasing cost as water depth increases.
Critics such as the Club of Rome argue that a narrow view of economic growth, combined with globalization, is creating a scenario where we could see a systemic collapse of our planet's natural resources.
Concerns about possible negative effects of growth on the environment and society led some to advocate lower levels of growth. This led to the ideas of uneconomic growth and de-growth – and Green parties that argue that economies are part of a global society and global ecology, and cannot outstrip their natural growth without damaging those.
Those more optimistic about the environmental impacts of growth believe that, though localized environmental effects may occur, large-scale ecological effects are minor. The argument, as stated by commentator Julian Lincoln Simon, states that if these global-scale ecological effects exist, human ingenuity will find ways to adapt to them.
Up to the present there are close correlations of economic growth with carbon dioxide emissions across nations, although there is also a considerable divergence in carbon intensity (carbon emissions per GDP). Globally, Tim Garrett observes that the emissions rate is directly related to the historical accumulation of economic wealth. The Stern Review notes that the prediction that, "Under business as usual, global emissions will be sufficient to propel greenhouse gas concentrations to over 550ppm CO
2e by 2050 and over 650–700ppm by the end of this century is robust to a wide range of changes in model assumptions." The scientific consensus is that planetary ecosystem functioning without incurring dangerous risks requires stabilization at 450–550 ppm.
As a consequence, growth-oriented environmental economists propose massive government intervention into switching sources of energy production, favouring wind, solar, hydroelectric, and nuclear. This would largely confine use of fossil fuels to either domestic cooking needs (such as for kerosene burners) or where carbon capture and storage technology can be cost-effective and reliable. The Stern Review, published by the United Kingdom Government in 2006, concluded that an investment of 1% of GDP (later changed to 2%) would be sufficient to avoid the worst effects of climate change, and that failure to do so could risk climate-related costs equal to 20% of GDP. Because carbon capture and storage is as yet widely unproven, and its long term effectiveness (such as in containing carbon dioxide 'leaks') unknown, and because of current costs of alternative fuels, these policy responses largely rest on faith of technological change.
On the other hand, British conservative politician and journalist Nigel Lawson claimed that people in a hundred years' time would be "seven times as well off as we are today", therefore it is not reasonable to impose sacrifices on the "much poorer present generation".
While acknowledging the central role economic growth can potentially play in human development, poverty reduction and the achievement of the Millennium Development Goals, it is becoming widely understood amongst the development community that special efforts must be made to ensure poorer sections of society are able to participate in economic growth. The effect of economic growth on poverty reduction - the Growth elasticity of poverty - can depend on the existing level of inequality. For instance, with low inequality a country with a growth rate of 2% per head and 40% of its population living in poverty, can halve poverty in ten years, but a country with high inequality would take nearly 60 years to achieve the same reduction. In the words of the Secretary General of the United Nations Ban Ki-Moon:
While economic growth is necessary, it is not sufficient for progress on reducing poverty.
Some physical scientists like Al Bartlett regard continuous economic growth as unsustainable. Several factors may constrain economic growth - for example: finite, peaked, or depleted resources. Many basic industrial metals (copper, iron, bauxite, etc.), as well as rare-earth minerals, face output limitations. Concerns over future oil production rates are well documented. Petroleum (see Peak oil) and other non-renewable energy sources are limited.
Some Malthusians, such as William R. Catton, Jr., author of the 1980 book Overshoot, express skepticism of the idea that various technological advancements will make previously inaccessible or lower-grade resources more available. Such advances and increases in efficiency, they suggest, merely accelerate the drawing down of finite resources. Catton refers to the contemporary increases in rates of resource extraction as, "...stealing ravenously from the future". The apparent and temporary "increase" of resource extraction with the use of new technology leads to the popular perception that resources are infinite or can be substituted without limit, but this perception fails to consider that ultimately, even lower-quality resources are finite and become uneconomic to extract when the ore quality is too low.
Lack of credit may constrain growth.