Economic growth and development

Economic growth and development The economic development of a country or society is usually associated with (amongst other things) rising incomes and related increases inconsumption, savings, and investment. Of course, there is far more to economic development than income growth; for if income distribution is highly skewed, growth may not be accompanied by much progress towards the goals that are usually associated with economic development. characteristics in equal measure. And, some of you might even question the presence of certain items in the above list, pointing perhaps to countries (or regions within them) in which, for example, crime and employment levels appear to be quite high, or highlighting the fact that not everyone has access to good public services, housing and so on. Some of these points are clearly open to debate. For instance crime levels in the rural areas of many developing countries where most people live are often much lower than in some of the urban population centres of developed countries. Nonetheless, the above list is probably fairly indicative of the characteristics that distinguish countries that are economically developed from those that are not. Economic growth From the answer to the previous question you will have noticed that the listed characteristics once again say more about goals than the processes or mechanisms for achieving them. So what drives a country towards achieving these goals? The orthodox view, espoused by most governments, most major international organisations, and the economists that advise them, is that a big part of the answer lies in economic growth. However, economic growth can follow many different paths, and not all of them are sustainable. Indeed, there are many who argue that given the finite nature of the planet and its resources, any form of economic growth is ultimately unsustainable. We shall leave these debates for later. For now let us look at what exactly economic growth is and how it is measured. Economists usually measure economic growth in terms of gross domestic product (GDP) or related indicators, such as gross national product (GNP) or gross national income (GNI) which are derived from the GDP calculation. GDP is calculated from a countrys national accounts which report annual data on incomes, expenditure and investment for each sector of the economy. Using these data it is possible to estimate the total income earned in the country in any given year (GDP) or the total income earned by a countrys citizens (GNP or GNI). GNP is derived by adjusting GDP to include repatriated income that was earned abroad, and exclude expatriated income that was earned domestically by foreigners. In countries where inflows and outflows of this sort are significant, GNP may be a more appropriate indicator of a nations income than GDP. There are three different ways of measuring GDP • the income approach • the output approach • the expenditure approach The income approach, as the name suggests measures peoples incomes, the output approach measures the value of the goods and services used to generate these incomes, and the expenditure approach measures the expenditure on goods and services. In theory, each of these approaches should lead to the same result, so if the output of the economy increases, incomes and expenditures should increase by the same amount. Figures for economic growth are usually presented as the annual percentage increase in real GDP. Real GDP is calculated by adjustingnominal GDP to take account of inflation which would otherwise make growth rates appear much higher than they really are, especially during periods of high inflation. Shortterm versus longterm growth A distinction needs to be made between shortterm growth rates and longer term ones. It is quite normal for shortterm growth rates to fluctuate in line with the business cycle. This can be seen in the two figures in 1.2.1 representing GDP growth in the US between 1930 and 2003. According to the measures of GDP and growth shown here, growth in recent decades has fluctuated between zero and 5% per annum. Clearly, based on longterm trends, growth rates exceeding 5% (as measured here) would seem to be unsustainable. When politicians are talking about sustainable growth they are often referring to macroeconomic concerns relating to the cycle of boom and bust. An economic boom involves high growth rates and is often accompanied by rising inflation. It is often followed by a period of lower growth rates and recession (bust). Sustainable growth in this context relates to stable growth rates that even out the fluctuations in the business cycle, thus avoiding high peaks and the large troughs associated with recessions. Note that this is different from the issues that environmentalists typically focus upon when they discuss the sustainability of economic growth. We shall say more on this later. Relationship between growth and development Do high levels of GDP necessarily correspond with high levels of development? Not necessarily. It is not aggregate GDP that is important, but GDP per capita. Countries like China and India have much higher levels of GDP than, say, Singapore, New Zealand or Belgium, but few would suggest that the latter are economically less developed than the former. Certainly, statistics reveal that the most developed countries are those with the highest GDP per capita (see Easterly 2002). Clearly, though, GDP per capita doesnt tell the whole story. GDP per capita is calculated by dividing GDP by the population. It says nothing about how incomes are distributed or spent. Growth in GDP per capita could result from growth in the incomes of richer groups in society, with incomes of poorer groups remaining largely unchanged. It coincides with spending patterns that are skewed towards the rich and which exclude the needs of the poor. It doesnt necessarily follow that growth in per capita GDP will lead to a reduction in poverty or to broader social and economic development. Indeed, there are those who argue, rightly or wrongly, that in many countries economic growth is associated with increasing levels of poverty, rather than the reverse. The relationship between economic growth and poverty is a hotly debated topic, about which people are very divided. Some people highlight the negative effect of growth on low income groups, stressing the need for new approaches to economic development that will allow the poor to benefit more from economic growth than they do at present. Others are more sanguine, believing that the benefits of current models for growth will eventually trickle down to poorer groups in society, if they are not already doing so. Much of the debate in this area revolves around the values and ideals of those engaged in it, as well as the different theories on the subject. It also hinges upon interpretations of the empirical evidence. Poverty and income distribution are hard to measure, especially in developing countries where the capacity to gather and analyse data is often very weak. Consequently, the strength of the statistical relationship between growth and poverty remains the subject of debate. There is also controversy about the mechanisms by which economic growth may reduce poverty, the timing of these and the policy implications. GDP and purchasing power parity An additional problem with GDP as a measure of development occurs when one compares per capita GDP across countries. This problem arises because one US dollar in the United States or Europe, for example, does not buy the same amount of goods and services as it would do in, say, Africa or Asia. For many goods and services one dollar will purchase significantly more in a developing country than it will in a developed one. To overcome this difficulty, economists often use purchasing power parity (PPP) dollars when making crosscountry comparisons of GDP. These are dollars that are adjusted to account for the differences in purchasing power between different countries. Human development index The weaknesses inherent in the use of GDP as a measure of development has led to the creation of other measures. The most well known of these is the human development index (HDI) published on a regular basis by The United Nations Development Programme (UNDP) in itsHuman Development Report. The HDI is a composite index that rates countries according to their overall performance in relation to three criteria • life expectancy • education • per capita GDP (using PPP dollars) As noted earlier, these are related to fundamental freedoms to live and to participate in society.