‘Economic Growth’ is a term which one often sees in the media. It is also looked at closely by the economists, the government and the people. Economic growth tends to show the rate of growth of an Economy
The chart graphs the growth rate of the Indian Economy.
What is this ‘Economic Growth’?
Economic growth is the increase in value of the goods and services produced by an economy. It is conventionally measured as the percent rate of increase in real gross domestic product, or GDP. [Wikipedia]
Economic growth has become the Holy Grail of the 20th century. [Lewis 1974] The ‘saga’ continues. Governments like projecting a target rate of growth (The higher the better) for the economy and the economists like to fiddle around with the projected targets.
Why ‘growth’ happens?
One factor which caused growth is said to be the increments in capital. This ‘link’ was given to us by Roy Harrod in the 1940’s. This causality led to the policy of increased expenditure on capital mainly by the government, so as to ‘grow in GDP’.
In the 1950s, Robert Solow (1956) of MIT generalised the relationship between capital, labour, technology and output in the neat little “neoclassical production function”, which still lies at the heart of contemporary growth accounting exercises. Other theorists (as well as planners and policy-makers) also emphasised the importance of education (human capital) and technological development in spurring sustained growth. [Acharya 2006]
Economic growth was caused by capital accumulation, or a rise in the ratio of investment to income and/or increasing efficiency and productivity. [Roy 2006]
Thus, basically with growth in labour, capital (Physical and Human) and technology, there will be growth in the economy too.
According to Paul Romer, three broad factors contribute to growth in output per capita:
1) Increases in physical capital – the buildings, machinery, and infrastructure that we use in daily life.
2) Increases in human capital – the skills and experience of the workforce.
3) Increases in productivity – a catchall category that includes the many large and small discoveries that lead to the introduction of new goods and services or to more efficient production of existing goods and services.
The significance of economic growth
History shows us that a small permanent increase in the trend rate of growth can profoundly alter our quality of life. [Romer 2001]
Keeping this in mind, economic growth acts as an important indicator. So Governments try to achieve high rates of growth so as to provide their respective nations with a high quality of life. But, quality of life is better measured using the HDI rather than GDP.
There is, indeed, a positive relationship between rapid economic growth and a victory over poverty. But this does not happened automatically. A good economics that concentrates on the even distribution of economic opportunities and benefits is essential. And further, good economics has to be also combined with sensible and responsible politics. [Alexander 2005]
Early works on Economic Growth
Robert M. Solow, the Nobel Prize winner in 1987 says in his Prize lecture “Growth theory did not begin with my articles of 1956 and 1957, and it certainly did not end there. Maybe it began with The Wealth of Nations; and probably even Adam Smith had predecessors.”
Some of the economists who worked on growth models prior to Solow were Roy Harrod, Evsey Domar and W. Arthur Lewis.
It is the GDP rate which appears to be more of a concern than the HDI, which does not enjoy the limelight as GDP does. Both these criteria are important and thus the need for understanding both of them.