Economic growth Essay

Economic growth refers to the increase in the levels of a country’s wealth and capital as a result of positive change in the levels of production of goods and services during a certain period of time. 1 Economic growth is usually ignited by technological advancements and positive external forces. Economic growth can be measured either in terms of nominal growth or real growth. Nominal growth takes inflation into account and thus demonstrates economic growth as Net Domestic Product while real growth does not account for inflation and thus demonstrates economic growth as Gross Domestic Product. Economic growth is usually determined by levels of Gross Domestic Product (GDP). GDP is the preferred means of measuring economic growth because increase or decrease in the GDP levels in a country reflects the real the standards of living of its population. GDP is the total market value of all final products of all final goods and services produced in a country in a given year expressed in money value. 2 GDP of a country equals total consumer investments and government spending, plus the value of exports, minus the value of imports. As such, GDP can be summarised as follows: †¢ GDP = Consumption + gross Investment + Government Spending + (Exports-Imports) or simply GDP = C+I+G+(X-M). However, it must be noted that economic growth entails more than just mere change of scale of economic magnitudes. By its very own nature, growth modifies economic structures thereby adjusting the general technological and social dynamics in a country. Bourguignon points out that economic growth may modify the sectoral structure of an economic unit, leading to close down of firms in one sector and creation of new firms in another. 3 Bourguignon further notes that â€Å"growth modifies the structure of prices, thus affecting the standard of living in households in a way that depends on their consumption preferences†. 4 Moreover, economic growth calls for increased technological innovations which in turn increases the necessity for increased technological knowledge and skills, a situation that would require increased investment in education and better remuneration for holders of such important skills. The final and most important attribute of economic growth is that it reduces the abundant availability of public goods such as adequate water supply and clean air due to increased pollution. Consequently, this may call for intervention and preventive measures in order to maintain adequate supply of the environmental goods. Therefore, economic growth impacts on the economy, social structures and environmental factors of a country. Therefore, people, as the human factors of economic growth remain very important components of economic growth. While economic growth is primarily driven by state dynamics and machinery, the interactions within the societal fabric bear consequential impact on the manner in which economic growth may either be beneficial or harmful to the long-term interest of the people. 5 Therefore, the pursuit of economic growth presents as much benefits as threats to the long-term interests of the people. The different principles and models of economic growth are best demonstrated by different existing theories of economic growth. 1. J. Mokyr, Long-term economic growth and history of technology, Department of Economics and history, Northwestern University, 2005, p. 33 2. R. Lucas, lectures on economic growth, Cambridge, Harvard University Press, 2002, p. 41 3. F. Bourguignon, Handbook of economic growth, World Bank, 2006, p. 7 4. F. Bourguignon 5. E. Helpman, The mystery of economic growth, Cambridge: Harvard University, 2004, p. 7 Theoretical background Although there are many theories and models of economic growth, the exogenous theory of economic growth and the endogenous theory of economic growth provide the most vivid theoretical background on issues concerning economic growth. The exogenous theory was advanced by the neo-classical theorists while the endogenous theory was advanced by the modern economic theorists. The exogenous theory of economic growth was advanced by Robert Solow and Trevor Swan. The theory states that â€Å"long-run rate of growth of a system is determined by forces outside the system†. 6The main prediction of this theory is that an economy will always converge towards a steady state of growth which depends absolutely on the rate of technological progress and growth of labour. The theory is based on a series of equations which demonstrate the relationship between labour, time, capital goods, output and investments. The main argument of the exogenous growth theory is based on the assumption that capital expansion is subject to diminishing returns. Therefore, given a fixed amount of labour force, the impact on the output of the last unit of capital accumulated will always be less than the impact on the preceding units. 7 This cycle continues to a point where new amounts of technological progress and labour force adds no new value to capital produced. New technological innovations and labour force output only serve to replenish the loss of value to existing capital due to depreciation. Solow and Swan refer to this as static state of growth. Modern theorists such as Barro, Ormerod, and Romer disagreed with the idea of static state of growth subject to diminishing returns as advanced by the exogenous theorists. They therefore developed a more relevant and realistic theory that came to be referred to as the endogenous theory. Proponents of endogenous growth theory argue that comparisons between trends of production in industrialised countries today and before industrialisation reveal that growth was generated and sustained by forces within as opposed to forces outside the countries. The endogenous theory states that â€Å"economic growth is generated from within a system as a direct result of internal processes†. 8 according to the endogenous theorists, improvement in productivity can be linked to a faster pace of innovation and committed investment in human capital. â€Å"The theory notes that the enhancement of a nation’s human capital will lead to economic growth by means of the development of new form of technology that will lead to efficient and sufficient means of production†. 9 The main focus of the endogenous theorists lies on the need for both government and private sector institutions to nurture innovations through incentives that will encourage individuals to be innovative. As Romer points out, â€Å"the rate of technological progress should not be taken given in a growth model, but rather, appropriate government policies have to be applied in order to raise a country’s growth rate†. 10Such policies should particularly be targeted towards creating higher levels of competition in markets and greater innovation initiatives among individuals. Endogenous theorists identify private investment in research and development as being the key driving force for technical progress. Furthermore, protection of property rights and patents can provide the incentive to engage in research and development. 6. R. M. Solow, Review of economics and statistics, Technical change and the aggregate production function 1957, P. 39 7. Solow 8. P. Romer, Review of economics and statistics, Technical change and the aggregate production function 1957, P. 73 9. Romer p. 74 10. Romer p. 81 Why the pursuit of economic growth is not in people’s long-term interest Concerns to the effect that the pursuit of economic growth is not in people’s long-term interest are very much validated by the current worrying trends of economic growth. While proponents of economic growth cite many benefits associated with economic growth, such benefits only stand to serve people’s short-term interests. It is increasingly becoming apparent that just like the past, the current economic growth initiatives are being undertaken with little regard to long-term repercussions of such initiatives. One of the most important long-term interests that economic growth should guarantee is the safety and conservation of the ecosystem, which will in turn guarantee people’s long-term interests. To the contrary, the aspects of the safety of natural resources and the environmental preservation are the most abused by economic growth. Yet, the gradual destruction of the environment harbours the risk of eventual destruction of the planet earth. Without action on climate change, economic growth and development are likely to generate levels of greenhouse gas emissions that would be very damaging. 11 Economic growth is evidently increasing the demand for fossil-fuel energy, thus the failure to implement appropriate international collective actions will allow manufacturers and consumers to continue with their risky energy consumption behaviours, thereby posing greater threats of adverse climatic change. Adequate supply of the environmental goods is facing continuous challenges as economic growth continues to wreck havoc on the environment. The Stern Review Report on the Economics of Climate Change (2006) identified that the world ecosystem is facing threats of eminent destruction due to increased levels of greenhouse emissions to the atmosphere. According to the Stern Report, greenhouse-gas concentrations in the atmosphere stood at around 430 CO2 equivalents as of 2006, compared to 280ppm before industrial revolution. 12The overwhelming pollution is as a result of combined forces of emissions of toxic gases from the power sectors, transport sectors, building sectors, industry sectors, land use sectors and land use sectors throughout the world. Indeed, these particular sectors represent the key driving forces of economic growth. As pointed out in the Stern Report â€Å"emissions have been driven by economic development. Carbon dioxide emissions have strongly been correlated with GDP per head across time and countries. North America and Europe have produced around 70% of carbon dioxide emissions from energy production since 1850, while developing countries account for less than one quarter of cumulative emissions. †13 Annual emissions are increasing at constant rates year after year. Between 1950 and the year 2000, emission of Carbon dioxide which accounts for the largest share of green house gases, grew by 2. 5% annually. 14The Stern Report further warns that without action to combat climate change, atmospheric concentration of green house gases will continue to rise. â€Å"In a plausible business as usual scenario, they will reach 555ppm CO2e by the year 2035†. 15 Moreover, total emissions are bound to increase more rapidly than emissions per head in tandem with the projections that global population will remain positive until 2050. 11. Stern Review report on economics of change, Impact of climate change on growth and development, November 2006, p. 169 12. Greenhouse gases are usually converted to a common unit, CO2 equivalent, which measures the amount of carbon dioxide that would produce the same global warming potential (GWP) over a given period as the total amount of greenhouse gas in question. 13. Stern Review report on economics of change 14. Stern Review report on economics of change 15. Stern Review report on economics of change These are the most shocking revelations concerning the gradual and unabated destruction that economic growth is imposing on the environment! The future generations remain exposed to the risks of frequent disasters that are associated with global warming. Such risks include food and water shortages, increase air pollution, increased desert cover, rise in sea levels as well as increased frequencies of tornadoes and tsunamis. Obviously, such threats of climatic change will impact negatively on population growth and living conditions for the people in future. Table 1 demonstrates a variety of experiences across different countries of the world. The EU and the economies in transition reported considerable reduction in carbon intensity during the period. However, India went against the grain and significantly increased carbon emissions during the same period. Developing countries registered significant growth in populations as well as growth in GDP per head. Equally notable is the tremendous decrease in the energy intensity of output in India and China. This table clearly demonstrates that despite the high levels of emissions, many countries undertook important economic reforms in the 1990’s, a move that led to marked improvements in utilisation of energy, with many countries registering significant reductions in wasteful use of energy. Risks posed by economic growth are set to reduce with increased adoption of energy efficient production strategies that will ensure environmental conservation while not hurting long-term growth rate targets. Why the pursuit of economic growth is in people’s long-term interest Despite the many reservations that opponents of economic growth have, there exists a general consensus that economic growth is a prerequisite requirement for the well being of the current and future generations. The future can only be secures through persistent creation of wealth and capital. Industrial revolution is credited for having ignited economic growth and eventual improvement of living standards. â€Å"The significance of industrial revolution is best captured by the Malthusian theory of economic growth which argues that industrial revolution and advancement in medicine translated to increased life expectancy and reduced infant mortality†. 15 15. R. Lucas, lectures on economic growth, Cambridge, Harvard University Press, 2002, p. 49 According to the Malthusian theory, this industrial revolution culminated to increased income and population growth and eventual increase in income per capita in industrialised counties, and lasted for many years thereafter. 16Therefore, economic growth remains a very important component sustained development of both current and future generations. Conclusion It is evident that economic growth also corresponds to processes of rapid replacement and reorganisation of human activities as well as natural resources, all in the spirit of investment and maximisation of returns. As such, â€Å"this realisation of the exponential abilities of the human race, as facilitated by self-organised life support and cultural systems, is a confirmation of the creative and flexible nature of human beings which however, is highly unpredictable in many ways. 17 Environmental threats posed by economic growth not withstanding, economic growth remains an important transition that this world must undergo. Therefore, the challenges posed by economic growth can best be tackled through creation of a balance between the conflicting concepts economic growth and mitigation of risks posed by economic growth. Economic growth is a manifestation of technological change. â€Å"Yet the essence of technological modernity is non-stationery: many scholars have acknowledged that technological change has become self propelled and autocatalytic, whereby change feeds on change. Thus unlike other form of growths, technology is not bound from above. Inventions have become a norm thus are unstoppable by forces of any nature. †18 The stern Report acknowledges that â€Å"the relationship between economic growth and CO2 emissions is not immutable. There are practical examples where change in energy technologies, the structure of economies and the pattern of demand have reduced the responsiveness of emissions to income growth, particularly in the richest countries. Strong deliberate policy choices will be needed, however, to decarbonise both developing countries on the scale required for climate stabilisation†. 19 This is in itself a confirmation that effective protection and conservation of the environmental goods can be achieved tremendously through the adoption of energy efficient production strategies that will ensure environmental conservation while not hurting long-term growth rate targets. However, wide reaching strategies should be employed in the noble cause of environmental protection. Strategies that are over reliant on reduction of fossil fuels may not be enough to stop the overwhelming emissions of poisonous gases. Other strategies such as radical shift shifts towards service based economies have proved effective in slowing down or reversing the increase in emissions of poisonous gases to the atmosphere. 20There should also be increased lobbying for the adoption of the Kyoto Protocol of Climate Change by all countries in the world, including the United States. Being the world’s largest economy, the United States releases the highest amounts of toxic gas emissions to the atmosphere, yet the country has refused to recognise the Kyoto protocol which seeks to protect the world from being further exposed to the threat of climatic change. 16. R. Lucas, lectures on economic growth, Cambridge, Harvard University Press, 2002, p. 48 17. E. Helpman, The mystery of economic growth, Cambridge: Harvard University, 2004, p. 16 18. J. Mokyr, Long-term economic growth and history of technology, Department of Economics and history, Northwestern University, 2005, p. 37 19. Stern Review report on economics of change, Impact of climate change on growth and development, November 2006, p. 169 20. Stern Review report on economics of change Bibliography Aghion, P. & Steven N. Durlauf, (Ed), Handbook of economic growth, Vol. 1B. Elsevier B. V. , 2005. Bourguignon, F. Handbook of economic growth, World Bank, 2006. Helpman, E. The mystery of economic growth, Cambridge: Harvard University, 2004 Larry E. J. Neoclassical models of endogenous growth: the effects of physical policy, innovations and fluctuations, Elsevier B. V. 2005 p. 9-32. Lucas, R. lectures on economic growth, Cambridge, Harvard University Press, 2002 Mokyr, J. Long-term economic growth and history of technology, Department of Economics and history, Northwestern University, 2005, p. 32 – 43 Romer, P. Journal of Political Economy, Endogenous technological change, Vol. 98, No. 5, Oct. 1990. p. 71-102. Solow R. M. Review of economics and statistics, Technical change and the aggregate production function 1957, P. 37-51 Stern Review report on economics of change, Impact of climate change on growth and development, November 2006, retrieved on 29 March 2007, < http://www. hm-treasury. gov. uk/media/3/2/Chapter_7_Projecting_the_Growth_of_Greenhouse-Gas_Emissions. pdf