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Chapter Four - Economic Growth

Definition

Economic growth (which is G or g in the Kaya Identity), is defined as the increase per capita of gross domestic product (GDP).  It is, typically, reported as the annual change in real GDP; that is allowing for inflation.

Components

Economic growth is driven primarily by improvements in productivity; essentially the ability to produce more goods and services with the same inputs of labour, capital, energy and materials aided by technology advancements.

Short-run vs. Long-run

Economists distinguish between short-term economic stabilisation (the business cycle) and long-term economic growth.  The long-run path of economic growth is one of the central questions in economics since increases in GDP are, generally, equated to increases in standards of living.  Small differences in growth rates can result in big differences when compunded over years.  For example, an 8% growth rate leads to a doubling of GDP within just 10 years.  Differences in growth rates between countries can similarly lead to wide gaps developing in relative standards of living.  As such, the pursuit of economic growth has become a major policy focus of governments globally, particularly since World War II.

Drivers

But what drives economic growth?  In the UK, since the onset of the Industrial Revolution at around 1750, long-term growth has averaged roughly 2% per annum.  It is argued that a major factor spurring economic growth since that time has been the substitution of energy for human and animal labour and water and wind power - with this great expansion in total power underpinned by continuous improvements in energy conversion efficiency.  In short, economic growth centres on material throughput.

Over the last two centuries, a succession of civil and technological breakthroughs has been facilitated by the availability of cheap energy.  These include: the canals; railways and roads; new materials such as steel; the use of steam and the development of the internal combustion engine; mechanized agriculture; and scientific agriculture including chemical fertilizers and the Green Revolution.  Interchangeable parts, made with machine tools, have powered electric motors and resulted in universal mass production.

In the 20th Century, further advances were made after the Great Depression, which was caused, in part, by over-production in the 1920s.  New goods and services were invented and developed throughout the century and included: telephones; radion; television; cars; household appliances; air conditioning; commercial airlines; computers and the internet.  In the post-war period, the economy benefited from cheap energy in the form of vast oil discoveries, particularly in the Middle East.

Global View

Since the 1970s, growth has slowed in the West but has been strong in the East; firstly in Japan then spreading to Korea, China, India and other Asian countries.  Japan has since slowed but growth remains strong - particularly in China and, recently, India.

It is clear that the availability of cheap energy, combined with technological advances, spurs growth in economies.

Different Theories

To understand economic growth, four theories may be considered:


  • Classical Growth Theory - This considers labour and capital as primary sources of economic growth and holds technology as a constant.  This is now criticised widely as technology clearly plays a role in economic growth in modern economies, as do economies of scale.
  • Neoclassical Growth Theory - This theory, which was common in the 1950s, assumes that technology plays a role in the formulation of economic growth.  Eventually, all countries will have the same rate of economic growth, which is determined by the pace of technology change, and poor countries can become rich by investing a greater share of their GDP.  This is known as an 'exogenous' model because it does not explain why countries invest differently over time or why technology progresses.  Also, a criticism is that investment flows to poor countries - which have less capital per worker - have not happened on the whole.
  • Endogenous Growth Theory - This became popular in the late 1980s and early 1990s and sought a greater technology inclusion in economic growth theory.  For the first time, it included the concept of human capital which has increasing returns rather than diminishing returns (as with labour and capital).  Subsequently, research has focused on improving growth rates through education and innovation.
  • Unified Growth Theory - This is the latest economic theory, which builds on the Endogenous Growth Theory but seeks to explain the bridge between pre-industrial stagnation and post-industrial steady economic growth with technology playing an important role.
Although there are different theories, the current paradigm is that comparative advantage, free trade, capital accumulation, education and technological change are key, together with cheap energy.  The role that technology plays will be considered in Chapter 7 but it is worth noting here the work of Schumpeter on creative destruction whereby economies expand by capitalism, destroying mature industries but fostering innovation which, in turn, creates more capital better allocated to new industries.

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