What is economic growth?
Economic growth is the sustained increase in a country’s ability to create more goods and services over time. It is commonly measured using gross domestic product (GDP)—the value of all finished goods and services produced in an economy over a given period. For this article, an adjusted measure called real GDP per capita is employed as an indicator of economic growth. This measure neutralises the effects of changing populations and inflation on the GDP figures to give a more accurate representation of the actual state of the economy. Many stakeholders consider economic growth a key macroeconomic indicator because it creates jobs, reduces poverty and leads to a better quality of life.
Factors determining economic growth
Investment in capital goods and improvements in technology are two factors that contribute to economic growth. ‘Technology’ does not necessarily just relate to information technology but in this context, includes the underlying skills, techniques and methods used to generate outputs. By incorporating new technologies in the production process, there is increased productivity and output, increasing GDP.
Capital goods are structures and equipment used to produce other goods. They are essential investments to further boost output in the production process. For example, the introduction of computers and their software has increased productivity as data can be analysed more rapidly. Other examples of capital goods include office buildings, hand tools and factory equipment.
Changes in the working population can affect economic growth. For example, consider a sudden increase in the number of unemployed people due to an economic shock (such as the coronavirus crisis). This type of event decreases GDP because there are fewer people contributing to the overall economy.
As we will see in the following case studies, many other factors help explain economic growth. These include the ability and motivation for citizens to innovate, and also the political structure of a country.
Case study 1: the four Asian tigers
The Four Asian Tigers refer to the economies of Hong Kong, Singapore, South Korea and Taiwan. These four nations underwent an astounding rate of economic growth from the 1960s to the 1990s, averaging increases in real GDP per capita of six to seven per cent each year (compounded) as illustrated in Figure 1.
Apart from the two declines during the Asian Financial Crisis (1997) and the Global Financial Crisis (2008), the Tigers have largely maintained an increasing trend in their real GDP per capita since 1960. As of 2017, the real GDP per capita for Singapore, Taiwan and South Korea was at least 16 times higher than it was in 1960, while Hong Kong was at 11 times.
How was this growth possible? Firstly, each of the four nations had a high savings rate, which, according to the Solow-Swan model, allowed for greater investment in capital, resulting in increased productivity and output. Secondly, the Tigers also possessed some of the highest levels of investment in human capital (the skills and capabilities of the country’s population) through education, further increasing their productivity. South Korea and Taiwan created their competitive advantage over the western world in the IT and electronics sectors. At the same time, Singapore and Hong Kong became international financial centres.
Case Study 2: BRICS
BRICS is the acronym given to the five emerging economies of Brazil, Russia, India, China and South Africa. An economy is ‘emerging’ when it begins to show the characteristics of a developed market. A graph illustrating the real GDP per capita for the BRICS nations since 1960 is supplied below in Figure 2.
Figure 2 indicates the past 40 years have been met with little progress by both Brazil and South Africa in economic growth. China and India have both made steady progress in their growth, with smooth increases in real GDP per capita over the same period. Russia has been the most volatile of the five nations.
The first data point for Russia occurs at 1991 because it was previously part of the now non-existent Soviet Union. Between 1991 and 1999, Russia suffered an economic decline due to the government’s hesitation about how they were going to implement a market economy. Russia was able to recover in 2000 and produced an average economic growth rate of seven per cent per year for the next ten years (compounded).
China and India have seen most of its growth in the past 20-30 years. Many believe the catalyst to growth in these two nations was their transition from a planned economy to a more open market structure.
Brazil and South Africa have both seemingly fallen into the ‘middle-income trap’. This ‘trap’ arises when a developing country cannot remain competitive with more advanced economies and economic growth stalls. These two nations must innovate and improve upon current technology to transform themselves into developed countries.
What does this all mean for the countries that are looking to become developed? It means that investment in innovation to develop new and improved technology, even in just one sector, is essential to carve out a market share of the product for exportation and to avoid the ‘middle-income trap’. Governments must invest in their own people through education to obtain the human capital required for innovation. Economic liberation in the form of free markets and international trade is also required to kick-start economic growth. Successful economic growth requires difficult decisions to be made, but the potential upside to nations in the long term can be many times the initial investment outlay.
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