Economic wealth grows when the economy grows. All of the conveniences and benefits of modern life, such as entertainment, fast and efficient transportation and communications, advanced health care, and longer, healthier lives, are made possible by the economy. And the benefits continue to grow as the economy grows. Economic growth extends the frontier of production possibilities, which are simply the possible combinations of products that can be made with the available resources and technology. Economic growth raises living standards and increases real GDP per capita, but only if output is evenly distributed.
Brief history of economic growth
Before 1750 the economy was mainly agrarian, since the technology was primitive almost everyone had to produce enough food to survive. Then, in England, from the 1750s onwards, new inventions greatly increased agricultural and textile productivity and provided more efficient methods of cultivation, spinning and weaving. With a smaller proportion of the population being required for agriculture and textiles, much of rural agrarian society transformed into an urban industrial society, allowing workers to produce much more than just food.
Advances in metallurgy, especially in steel production, have greatly improved manufacturing in many areas. The invention of the telegraph in the 18th century and the telephone a few decades later enabled much faster communication than before, enabled world trade and allowed economies to take advantage of the comparative advantages of different countries.
Today, technology is improving much faster than at any time in history, especially with the advent of the internet, computerization, robotics, and artificial intelligence that will improve productivity across all sectors of the economy. In fact, robotics and artificial intelligence can eliminate the need for labor.
economic growth rate
Global statistics clearly show that small economies are growing faster than larger economies, not only because they are growing from smaller bases, but also because they can learn about new technologies from advanced economies without having to fund their own R&D . In fact, many investors in modern economies invest in emerging markets simply because such investments can generate higher returns than would be likely in larger, slower-growing economies. However, economic growth eventually converges to a steady state, which is between about 2% and 4% per year.
The growth rate of the economy can have a major impact on the well-being of its citizens. For example, an economy that grows by 2% will double in 35 years and double again in another 35 years. An economy that grows 3% will double in 23 years and 4 months, resulting in an eightfold increase in the same 70 years, which is a little less than an average lifetime. The economy will double in size at a growth rate of just 1%. Economists would therefore like to know what is causing economic growth, how it can be accelerated, and what are the best strategies to promote growth.
economic growth models
Economic growth comes from acquiring more resources or figuring out how to use available resources more efficiently. Thomas Malthus and David Ricardo, who were the first economists, thought that economic growth would be limited by the supply of land because themarginal utilityLand would decrease as less fertile land has to be used. However, they could not foresee how technology would alleviate many of agriculture's problems, nor did they foresee the tremendous expansion of the nonagricultural economy.
The basic model of economic growth is based on the Solow-Swan model of economic growth, first published independently in 1956 by Robert Solow and Trevor Swan.
Economic growth depends on the increase in capital and labour
Economic growth depends on corporate growth. Businesses want to grow to maximize profits. Businesses use capital and labor to manufacture their products.
Since labor and capital produce economic outcomes, economic growth obviously depends on increases in capital and labor. It also depends on the productivity of the inputs. theProductivity of an inputIt is the amount of output produced per unit of input and can be increased through technological improvements, economies of scale, and advances in knowledge.
labor productivityis often measured asperformance per hour worked, that is the amount of production that an average worker produces in 1 hour.
capital cityIt can be classified as physical capital or human capital.physical capitalIt is the equipment and structures used in the manufacture of products and services.human capitalIt is the knowledge and skills acquired through education, training and experience that enable workers to produce products and services.
An obvious example of physical capital is the infrastructure of modern economies, including roads, bridges, the power grid, and power distribution infrastructure. Without this physical capital, labor productivity would be significantly lower.
Human capital is also an important source of economic growth. Human capital grows with education, on-the-job training, vocational programs and higher education.
Recently, capital has grown much faster than labor, a pace that will only accelerate with the development of robotics and artificial intelligence. As populations slow in most modern parts of the world, most future productivity will come from investment in both physical and human capital.
Other factors affecting economic growth
Although capital and labor are the main determinants of economic growth, other factors can also influence the rate of growth. Weather can affect productivity, especially in agriculture. Major disasters, such as earthquakes and hurricanes, can also temporarily reduce economic growth, but generally result in higher economic growth for some time thereafter as populations recover.
The main obstacles to growth could be the result of political mismanagement and mismanagement of the economy where production is not operating at full potential.
Production function, marginal product of capital and labor
losaggregate production functionrepresents the relationship between GDP (Y) and labor (L) and capital (K).
Y = F (K, L)
According to this simple model, increases in output depend on increases in labor and capital. If both are doubled, the output is doubled:
2Y = F(2K, 2L)
However, if either capital or labor increases while the other factor input remains constant, returns will decrease for each increasing unit factor input. themarginal product of capital(MPK) is the additional output created by additional capital given constant work.
As long as the profit increases exceed the additional cost of capital, a company can increase its profits by increasing its capital. However, if labor is constant, the marginal product of capital will increase rapidly at first, but then level off until no further increases in profits can be expected. This happens because labor with capital becomes more productive, but only up to a point. After that, the profit can only be increased by increasing the work.
Since labor is an input to any firm, labor also has a marginal product, which of course is called thatmarginal product of labor(MPL), that is the extra output that can be created with more labor that capital keeps constant. As with capital, profit can be increased by additional labor so long as the marginal product of labor exceeds its cost, namely workers' wages.
Comparing the production of labor and capital with their costs shows an optimal combination of inputs that produces the highest profits. Therefore, trading profits can be maximized if the capital-to-labor ratio (k) is optimized.
Capital formation depends on savings, investments and depreciation
GDP depends on household consumption, business investment, government spending and international trade:
Y = C + I + G + NX
Imports and exports can be accepted with a net value of 0 in the long term; otherwise trade surpluses or deficits would increase indefinitely, which is not sustainable, so the equation above can be simplified by eliminating NX.
GDP can also be measured by what households do with their income: spend on consumer goods, pay taxes and save:
Y = C + T + S
Therefore, the financing of business investment will depend on the level of household savings. Since households only have limited funds and the state sets the tax rates, there is a trade-off between consumption and savings. The more the household consumes, the less it saves and less funds are left for investments.
Private savings are also supplemented by public savings. The state spends part of the tax money, for example on the national infrastructure, i.e. roads, bridges, water supply and waste disposal. Governments also pay for research and development, especially for projects that would otherwise not be funded by private companies. It also pays for education and training, which is more general than on-the-job training provided by private companies. As with private saving, there is a trade-off between public spending and public saving: the more the state spends, the less it can invest.
Therefore, the total funds available for wealth accumulation depend on both public and private savings.
Economic growth depends on the total capital available, so capital accumulation can increase economic growth. Capital has a finite useful life, so capital accumulation depends not only on the investment rate but also on the capital depreciation rate. All capital has a finite useful life, so at least some of the new capital must be used to replace old capital. Economic models assume that depreciation is a constant percentage of total capital. So if δ is the depreciation rate, capital accumulation can be represented as:
Net capital accumulation for the next period =
investment during this period
+ Capital in this period
− depreciation rate × capital in this period
or using standard business notation:
kt+1= fromt+ kt(1 - again)
When the growth rate of capital exceeds the rate of depreciation, capital will accumulate; otherwise it will be less. In most economies, the economy converges to a steady state where investment equals depreciation. This steady state depends on the savings rate.
The savings rate determines the level of GDP per capita in the long run, but has no influence on the growth rate of GDP per capita in the long run. Increasing the savings rate will increase the growth rate of GDP per capita, but only temporarily until it reaches a higher steady state.
Technology will also have a significant impact on depreciation as technology helps produce better quality products for much longer. The cars, for example, are of much better quality and last much longer than yesterday's cars. LED bulbs last more than 30 times longer than incandescent bulbs and produce the same light output with less than 10% of the electricity consumption. As technology improves the lifespan of capital, more capital is accumulated per unit of investment.
The growth rate of the economy is proportional to the growth rate of capital, labor and technological advances.
Since economic growth depends on capital, labor and technology, the growth rate of the economy also depends on the growth rate of these inputs. Capital growth can be enhanced by higher savings and investment, but labor supply growth depends on the fertility rate of the population. It is further limited byactivity rate(LFPR). Labor statistics are collected in most economies, and in modern economies the LFPR is typically between 60% and 67%, which is a narrow range. Therefore, the increase in work is proportional to the LFPR percentage of population increase. In economics, the employment growth rate is often represented as gL.
The growth of capital and labor does not explain all economic growth. Technology is also an important driver of economic growth, but the quantitative impact of technology is not easy to measure. Instead, technological progress is presented for himTotal productivity factor, which adds to the explanation of economic growth to capital and labor increases.
production growth =
+ Growth in total factor productivity
steady state economy
Since labor is growing at a relatively constant rate and productivity is maximized at a given amount of capital per worker, ie the ratio K/L, the economy's growth reaches a steady state with a constant growth rate. Also, since the savings rate as a percentage of GDP is relatively constant, capital growth must also be relatively constant. Combine this with constant employment growth and you have constant GDP growth. The actual value of the K/Y ratio depends on the savings rate. When the savings rate increases, the K/Y ratio also increases, temporarily raising the rate of economic growth to a higher level; After that, the economy returns to a steady state, but at a higher constant level of growth.
Problems in measuring economic growth
The success of an economy is measured by how well it improves people's lives. Quantities are the easiest to measure, which is why most economies are measured by theirsgross domestic product, the value of all goods and services provided by a domestic industry. In order to improve people's lives, the quality of products and services is important, but quality cannot be easily measured. For example, telephones have come a long way since their invention in 1876, especially in the last 10 years as computer technology has enabled telephones to do much more than just communicate. And even for communication, phones have become much more efficient and portable, allowing people and businesses to communicate not only with voice but also with text messaging and social media. While it's easy to count how many phones have been produced and what their price is, it's much more difficult to measure improvements in quality, e.g. B. the many functions that apps offer, e.g. e.g. GPS. If GDP were only measured in terms of phones, it probably wouldn't have increased over the years, or GDP growth would be much more erratic than the economy's steady growth. This is because both the quantity and prices of the phones have changed over the years. For example, portable phones in the 1980s were much more expensive than today's mobile devices and had much less capacity, but there are also many more mobile phones than ever before. So it would be very misleading to measure the price and number of phones over the years, but it does give an indication of economic performance. Of course, some equality improvements are easier to measure than others, and government agencies report quality improvements when they can be measured consistently, but the measurement of quality will never be perfect.
Public policies to promote economic growth
Because the accumulation of both human and physical capital leads to higher economic growth, governments generally have strategies to encourage savings and investment that provide funding for capital expansion. Most governments allocate significant resources to human capital development. In the United States, significant state and local tax revenues are used to fund schools, but the federal government also provides fundingEducation through deductions and tax credits, enabling more people to afford education.
Since saving is necessary for investment, there are manyTax policy that encourages retirement savings, which will stimulate the economy by providing more funds for capital. Popular tax-advantaged retirement funds include individual retirement accounts and 401(k)s.
The most significant advantage that government can offer to business is the rule of law, specifically fair justice, where government or others cannot arbitrarily appropriate private property without due process of law. Even when there is a rule of law, it is often unfair for elites or societal interest groups to control the government and legislate to their benefit and at the expense of everyone else. People can also be discouraged from pursuing opportunities when significant artificial legal barriers are erected on existing businesses to suppress competition.
Efficient business and tax regulations are also required to enable efficient business transactions. Contracts must be enforced, property rights respected and bureaucracy minimized.
The government allocates significant funds to research and development, but it also has a patent system that allows companies to gain a legal monopoly on any new inventions they develop and patent. The downside of patents is that they can stifle innovation, as large companies hoard many patents and use the threat of patent infringement lawsuits to erect artificial barriers to entry to prevent the entry of any company that cannot or does not want to spend large sums of money. obliged to defend such cases, even if the claims are unfounded.
Some countries use aIndustrial policy, to promote specific industries where the government plays an active role in deciding how capital is allocated to manufacturing sectors. Industrial policies are enacted through tax credits, subsidies and special deductions. Japan, for example, had an industrial policy that encouraged the automobile manufacturing sector, in which it was very successful. But critics of industrial policy have argued that the government is picking winners and losers, something it is ill-equipped to do. And since investing comes with a high level of risk, allocating resources is best left to the private sector, which knows best how to build a profitable business and manage the risks involved.