Running head: GROWTH
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Growth
Suchayita Mukherjee
Capella University
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GROWTH
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Defining Economic Growth
The rate of economic growth and development of a country is a good measure of its
economic health. The economic growth of a country is defined as a sustained increase in the
volume of goods and services produced in the country. It can also be measured in terms of the
increase in the gross domestic product (GDP) of a country. “GDP is the market value of all final
goods and services produced within a country in a given time period” (Mankiw, 2012, p. 496).
Impact of Economic Growth
If the volume of goods and services of a country increases by 5%, the economic growth
rate of country can be said to be 5%. A high rate of economic growth, for example, 5%,
promotes capital formation by allowing investments in land, new machines, power,
transportation facilities, and so on. An increase in the stock of capital is likely to increase the
capital per worker, which will result in an increase in labor productivity. This further increases
economic growth (Mankiw, 2012). Economic growth also helps improve the quality of human
capital by allowing investment in education and training. It can also lead to technological
development, which involves both process innovation and product innovation. When growing at
a fast rate, a country can increase its spending on research and development, further boosting
technological advancement.
If the level of output of a country grows at a high rate, there is a boost in business
confidence and foreign investors are encouraged to invest in the country. A country can
participate in and gain from regional and international trade. This often increases the bargaining
power of the country in various global economic forums. Developed countries are significant
contributors to world trade and are therefore major players in the International Monetary Fund,
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the World Bank, and other global forums. Developed countries also attract multinational
companies, and most multinational companies have their head offices in developed countries.
The governments of developed countries, such as the United States, the United Kingdom,
and Germany, have greater economic power than the governments of underdeveloped countries,
such as Bangladesh, Ethiopia, and so on.
An increase in the volume of goods and services produced implies an increase in
production and employment opportunities, thereby reducing the unemployment rate in a country
and increasing the average income of its citizens. If a wide variety of goods and services are
produced, consumers can benefit from economic growth as they can choose from a large basket
of goods and services. A high rate of economic growth has other benefits for countries. As tax
revenue tends to increase with economic growth, governments need to borrow less from both
internal and external sources. A reduction in government borrowing can lower the debt to GDP
ratio. The governments of high-growth countries can also invest in pollution-control measures,
leading to a cleaner environment. They can also undertake the large-scale provision of public
goods and services.
If economic growth is accompanied by an improvement in the quality of life, literacy
rates, mortality rates, and life expectancy at birth, a country can enjoy a high level of economic
development as well, as measured by the Human Development Index (“Human development
index,” n.d.).
An increase in the rate of economic growth of a country can be accompanied by an
increase in the rate of population growth.
Economic Growth and Population Growth
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Comment [N1]: Your points about the
impact of economic growth were well taken.
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An increase in the size of a country’s population means an increase in the size of its
workforce and therefore an increase in the production of goods and services. Simultaneously, a
high level of economic growth can lead to an improvement in healthcare facilities, an increase in
life expectancy, and a decrease in infant mortality rates, leading to an increase in the growth rate
of the population. Economic growth may lead to an increase in the volume and variety of
products and an improvement in their quality. This may lead to an improvement in a country’s
standards of living. However, if the rate of growth of population equals or exceeds the rate of
economic growth, per capita income will not increase. If per capital income does not increase,
the standards of living may not necessarily increase. If the rate of economic growth of a country
is 5% and the rate of population growth is more than 5%, per capita GDP may not increase by
5%.
To sustain a high rate of economic growth, a country needs to maintain a high level of
investment.
The Role of Gross and Net Investment in Economic Growth
One of the factors that can stimulate economic growth is the amount of net investment in
a country. Net investment represents the actual amount of investment in a country and takes into
account the depreciation of existing equipment. On the other hand, gross investment includes the
total amount of investment in the country during a year. Therefore, net investment equals the
difference between gross investment and depreciation.
An increase in a country’s stock of capital indicates that net investment is greater than
zero. By contrast, when net investment is less than zero, the stock of capital in the country
decreases. As expenditure cannot be negative, the total actual spending on capital goods by a
country can be zero but not negative. Therefore, gross investment, which represents the total
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Comment [N2]: Does not explain how it
is impossible for gross investment to be
less than zero. You have to clarify
specifically why it is impossible to have
gross investment to be less than zero.
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amount of spending on capital goods, cannot be negative. Moreover, gross investment does not
take into account depreciation and therefore cannot be negative. Although gross investment can
decline to zero, this is unlikely. For gross investment to be zero, all firms in the economy should
have zero gross investment, which is improbable.
Gross investment in countries like Libya, Yemen, and Somalia is very low but not
negative. For example, the level of investment as a percentage of GDP in Yemen was 2% in
2015 (The World Bank, 2015). Even though the level of investment in Yemen as a percentage of
GDP has declined over the years, it continues to be positive. Gross investment can decline even
in developed countries during a recession or financial crisis. For example, in Greece, capital
investment as a percentage of GDP declined from 17.05% in 2010 to 11.48% in 2013 during the
debt crisis (“Compare countries using data from official sources,”, n.d.).
Net investment is negative when existing capital stock depreciates at a faster rate than it
is replaced. In other words, when depreciation exceeds gross investment, the values of all capital
goods in a country decline. Net investment is positive when gross investment exceeds
depreciation, indicating an increase in productive capacity.
Differences in net and gross investment can lead to substantial differences between
countries in terms of total capital formation, the rate of economic growth, standards of living,
and so on. The percentage of gross investment is higher in developed countries than in less
developed countries. For example, gross capital formation in Argentina as a percentage of GDP
decreased from 21% in 1966 to 17% in 2015, resulting in a growth rate of 2.4%. This was one of
the reasons why its growth rate decreased from 5.4% in 1966 to 2.4% in 2015 (The World Bank,
2015). On the other hand, a significant increase in gross investment in some countries has
contributed to their economic growth. For example, gross capital formation in Indonesia as a
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percentage of GDP increased from 6% in 1966 to 35% in 2015, resulting in an increase in its
growth rate (The World Bank, 2015). Some developed countries like Japan witnessed only a
slight increase in capital investment as a percentage of GDP from 19.82% in 2010 to 21.13% in
2013, leading to only a slight increase in GDP over this time period (“Compare countries using
data from official sources,”, n.d.).
Countries with high levels of investment experience high growth rates. For example,
capital investment in China as a percentage of GDP was 46% in 2015 and its growth rate was
6.9% in 2015. Similarly, capital investment in India as a percentage of GDP was 32% in 2015
and its growth rate was 7.6% during the same period (The World Bank, 2015).
Investment in research and technology can lead to the generation of new ideas and
improvements in the methods of production. Like investment, innovation plays a major role in
the economic growth of a country.
Role of Invention in Economic Growth
According to Paul Krugman, “a country’s ability to improve its standard of living over
time depends almost entirely on its ability to raise its output per worker” (1997, p. 11). Most
countries do not have an extensive reserve of mineral wealth or oil. Therefore, the only viable
way for these countries to become rich is by getting more output from the same number of
inputs. Innovation is one way through which productivity can be increased (Reamer, 2014).
There have been instances where inventions have led to large-scale economic expansion.
For example, during the First Industrial Revolution, the invention of power looms made the
production of high-quality cloth cheap. The British textile industry was the first industry to reap
the benefits of this change. There was major growth in the British textile industry and,
eventually, the British economy as a whole.
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Comment [N3]: Uses the concepts of
gross investment and net investment to
explain differences and similarities in
specific economies. Well done
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The last quarter of the 20th century saw the commencement of the information and
computer technology (ICT) revolution. There was an explosion of new discoveries and
inventions, causing such profound changes that some termed this phase of industrialization the
Second Industrial Revolution (Reamer, 2014). In the 20th century, the United States was
responsible for the development of new technology such as the internal combustion engine,
electricity, aviation, integrated circuits, and transistors. Since then, new inventions have
propelled economic growth, making the United States the world’s largest economy.
While some countries have attained a high rate of economic growth because of inventions
and improvements in technology, some countries have lagged behind because of several factors.
Factors that Restrict Economic Growth
There are several factors that can cause economic discrepancies among countries. One of
them is labor productivity. Labor productivity depends not only on the quality of labor but also
on the amount of capital, natural resources, and other inputs that are used with labor. Low per
capita income in poor countries makes investment in human and physical capital difficult,
keeping labor productivity low. The lack of education prevents the proper use of technology and
often leads to the underemployment of labor in poor countries.
Some countries have an abundant supply of natural resources. The Middle Eastern
countries of Bahrain, Qatar, Saudi Arabia, and the United Arab Emirates have huge oil reserves
and are classified as high-income countries. On the other hand, many developing countries such
as Chad and Ethiopia have a limited stock of natural resources, which acts as a constraint on
economic growth.
The absence of a well-developed and efficient financial system can also act as a
hindrance to economic growth in poor countries. When financial institutions fail to serve as
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Comment [N4]: Explains how a major
new invention can lead to economic
expansion; supports the explanation with
real world examples Good points.
GROWTH
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intermediaries between suppliers and borrowers, the lack of funds for investment becomes a
hindrance to economic growth. Some developing countries have serious deficiencies in their
physical infrastructure. Deficiencies in transportation, communication, sanitation, and electricity
can restrict a country’s growth. “Perhaps the most elusive ingredients for development are the
formal and informal institutions that promote production and exchange: the laws, customs,
conventions, and other institutional elements that sustain an economy” (McEachern, 2016, p.
431). A stable political environment with well-defined property rights is also necessary for
economic growth.
International trade patterns can also stifle growth. Less developed countries export
primary products, such as agricultural goods and other raw materials, and the prices of these
primary products fluctuate more widely than those of finished goods. When faced with a trade
deficit, poor countries restrict the import of capital goods, which are required for long-term
growth. Less developed countries also face trade restrictions imposed by developed countries,
such as tariffs and quotas. For example, the United States strictly limits sugar imports and this
can affect the less developed countries that export sugar.
Economic Growth and Convergence
Different countries grow at different rates. Despite this variation, less developed
countries can catch up with developed countries in terms of the growth rate. The convergence
theory states that “developing countries can grow faster than advanced ones and should
eventually close the gap” (McEachern, 2014, p. 419). This is because developing countries can
adopt the modern technology used by developed countries and grow at a fast rate. On the other
hand, developed countries need breakthroughs and innovative ideas to grow at a fast rate. Strict
patent and copyright laws are likely to promote innovation, but might make it difficult to
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improve production processes. Therefore, strict intellectual property rights could be
counterproductive and slow down growth in an economy.
The law of diminishing returns to capital states that as the stock of capital increases, the
extra output produced from an additional unit of capital falls. Diminishing returns to capital also
help in “making it easier for a country to grow fast if it starts out relatively poor” (Mankiw,
2012, p. 541). In poor countries, workers lack even the most rudimentary tools and, as a result,
have low productivity. Small amounts of capital investment can raise the workers’ productivity
substantially. By contrast, as capital per worker is already very high in developed countries,
additional capital investment has a relatively small impact on labor productivity.
“The newly industrialized Asian economies of Hong Kong, Singapore, South Korea, and
Taiwan, by adopting the latest technology and investing in human resources, have closed the gap
with the world leaders” (McEachern, 2016, p. 440). Between 1960 and 1990, the United States
and South Korea devoted a similar share of GDP to investment. Yet, over this time period, the
United States experienced a growth rate of only 2%, while South Korea experienced a growth
rate of more than 6%. This shows that developing countries may be able to close the gap with
developed countries.
However, both developing countries and developed countries face certain challenges to
attaining and maintaining high levels of growth.
Challenges of High Economic Growth
One of the challenges faced by countries with high rates of economic growth is
sustainable development. “Sustainable development is development that meets the needs of the
present without compromising the ability of future generations to meet their own needs”
(“Sustainable Development,”, n.d., para.2). According to the United Nations Department of
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Comment [N5]:
Uses the concepts of gross investment
and net investment to explain
differences and similarities in specific
economies. Good points
GROWTH
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Economic and Social Affairs (UN DESA), “over the past years, the global challenges to
sustainable development have been driven by a broad set of “megatrends,”, such as changing
demographic profiles, changing economic and social dynamics, advancements in technology and
trends towards environmental deterioration” (p. vi). UN DESA also pointed out that “the impact
of climate change threatens to escalate in the absence of adequate safeguards and there is a need
to promote the integrated and sustainable management of natural resources and ecosystems and
take mitigation and adaptation action in keeping with the principle of common but differentiated
responsibilities” (p. vi).
The distribution of income and the types of goods produced are some of the factors that
need to be addressed by countries that have a high growth rate. Developed countries also face
other issues like financial crises and recessions.
Financial Crisis and Recession
The financial crisis that rocked the United States of America in 2007 led to the Great
Recession of 2008. In mid-2013, the Federal Reserve adopted expansionary monetary policy,
lowering short-term interest rates to a historic low of 1 percent (Labonte, 2016). This increased
the demand for housing and led to sharp increases in housing prices. The financial crisis occurred
mainly because banks created huge amounts of money by giving mortgage loans (Amadeo,
2016). The money that was created led to inflated housing prices and speculation in financial
markets. As debt started rising faster than income, people were unable to repay the loans,
resulting in the banks becoming bankrupt. Once the banks limited their lending and prices began
to drop in 2006, borrowers had to sell their assets in order to repay their loans. This caused a
drop in housing prices, and the housing bubble burst. With home prices falling, fewer houses
were built, meaning fewer jobs in residential construction, furnishings, and other industries that
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relied on the housing sector. As a result, banks reduced lending even further. Thus, a downward
spiral began and the economy went into recession.
Fears about the effect of rising home foreclosures on the banking system led to a fullscale global financial panic in September 2008, triggering the collapse of Lehman Brothers, a
Wall Street investment bank. Consumers reduced their spending in the face of sliding home
prices, mounting job losses, and a collapsing stock market. This led to the recession of 2008
(Amadeo, 2016).
Comment [N6]: Your points were well
taken.
Conclusion
Economic growth plays an important role in reducing the poverty and unemployment in a
country. The rate of economic growth of a country depends on the level of gross investment and
net investment in the country. Innovation also plays a major role in the economic growth of a
country. The rate of growth varies between different countries. However, adopting modern
technology can help developing countries catch up with developed countries. Achieving high
rates of economic growth involves challenges for both developed and developing countries. For
example, the sustainability of growth is a challenge faced by developed countries. Developed
countries may also face financial crises that can lead to a recession, as evidenced by the
recession of 2008.
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References
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https://thebalance.com/how-hedge-funds-created-the-financial-crisis-3306079.
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Human development index (HDI). (n.d.) Retrieved from http://hdr.undp.org/en/content/humandevelopment-index-hdi
Krugman, P.R. (1997). The age of diminished expectations. Cambridge: MIT Press.
Labonte, M. (2016). Monetary policy and the federal reserve: Current policy and conditions.
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http://fas.org/sgp/crs/misc/RL30354.pdf.
Mankiw, N. G. (2012). Principles of economics. Mason, OH: South-Western Cengage Learning.
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_Growth_02-28-14.pdf
Sustainable development. (n.d.). International Institute for Sustainable Development. Retrieved
from http://iisd.org/topic/sustainable-development
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The World Bank. (2015). Gross capital formation (% of GDP) [Data Set]. Retrieved from
http://data.worldbank.org/indicator/NE.GDI.TOTL.ZS
United Nations Department of Economic and Social Affairs. (2013). World economic and social
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