Economic growth is the increase in the inflation-adjusted market value of the goods and services produced by an economy over time. It is conventionally measured as the percent rate of increase in real gross domestic product, or real GDP. Of more importance is the growth of the ratio of GDP to population (GDP per capita, which is also called per capita income). An increase in growth caused by more efficient use of inputs (such as physical capital, population, or territory) is referred to as intensive growth. GDP growth caused only by increases in the amount of inputs available for use is called extensive growth.
In economics, "economic growth" or "economic growth theory" typically refers to growth of potential output, i.e., production at "full employment". As an area of study, economic growth is generally distinguished from development economics. The former is primarily the study of how countries can advance their economies. The latter is the study of the economic development process particularly in low-income countries.
Growth is usually calculated in real terms – i.e., inflation-adjusted terms – to eliminate the distorting effect of inflation on the price of goods produced. Measurement of economic growth uses national income accounting. Since economic growth is measured as the annual percent change of gross domestic product (GDP), it has all the advantages and drawbacks of that measure.
- 1 Measuring economic growth
- 2 Importance of long-run growth
- 3 Theories and models
- 4 Determinants of per capita GDP growth
- 5 Other factors affecting growth
- 6 Environmental and physical constraints
- 7 See also
- 8 References
- 9 Further reading
- 10 External links
Measuring economic growth
Economic growth is generally calculated from data on GDP and population provided by countries' statistical agencies, although independent scholarly estimates are also available.
Importance of long-run growth
Over long periods of time, even small rates of growth, such as a 2% annual increase, have large effects. For example, the United Kingdom experienced a 1.97% average annual increase in its inflation-adjusted GDP between 1830 and 2008. In 1830, the GDP was 41,373 million pounds. It grew to 1,330,088 million pounds by 2008. A growth rate that averaged 1.97% over 178 years resulted in a 32-fold increase in GDP by 2008.
The large impact of a relatively small growth rate over a long period of time is due to the power of exponential growth. The rule of 72, a mathematical result, states that if something grows at the rate of x% per year, then its level will double every 72/x years. For example, a growth rate of 2.5% per annum leads to a doubling of the GDP within 28.8 years, whilst a growth rate of 8% per year leads to a doubling of GDP within 9 years. Thus, a small difference in economic growth rates between countries can result in very different standards of living for their populations if this small difference continues for many years.
Quality of life
Happiness has been shown to increase with a higher GDP per capita, at least up to a level of $15,000 per person. Economic growth has the indirect potential to alleviate poverty, as a result of a simultaneous increase in employment opportunities and increased labor productivity. A study by researchers at the Overseas Development Institute (ODI) of 24 countries that experienced growth found that in 18 cases, poverty was alleviated. However, employment is no guarantee of escaping poverty; the International Labour Organization (ILO) estimates that as many as 40% of workers are poor, not earning enough to keep their families above the $2 a day poverty line. For instance, in India most of the chronically poor are wage earners in formal employment, because their jobs are insecure and low paid and offer no chance to accumulate wealth to avoid risks; other countries found bigger benefits from focusing more on productivity improvement than on low-skilled work.
Increases in employment without increases in productivity lead to a rise in the number of working poor, which is why some experts are now promoting the creation of "quality" and not "quantity" in labor market policies. This approach does highlight how higher productivity has helped reduce poverty in East Asia, but the negative impact is beginning to show. In Vietnam, for example, employment growth has slowed while productivity growth has continued. Furthermore, productivity increases do not always lead to increased wages, as can be seen in the United States, where the gap between productivity and wages has been rising since the 1980s. The ODI study showed that other sectors were just as important in reducing unemployment, as manufacturing. The services sector is most effective at translating productivity growth into employment growth. Agriculture provides a safety net for jobs and an economic buffer when other sectors are struggling. This study suggests a more nuanced understanding of economic growth and quality of life and poverty alleviation.
Theories and models 
Classical growth theory
In classical (Ricardian) economics, the theory of production and the theory of growth are based on the theory or law of variable proportions, whereby increasing either of the factors of production (labor or capital), while holding the other constant and assuming no technological change, will increase output, but at a diminishing rate that eventually will approach zero. These concepts have their origins in Thomas Malthus’s theorizing about agriculture. Malthus’s examples included the number of seeds harvested relative to the number of seeds planted (capital) on a plot of land and the size of the harvest from a plot of land versus the number of workers employed. See: Diminishing returns
Robert Solow and Trevor Swan developed what eventually became the main model used in growth economics in the 1950s. This model assumes that there are diminishing returns to capital and labor. Capital accumulates out of saving but its level per worker decreases due to depreciation and population growth. As a result of diminishing returns to capital economies eventually reach a point where, absent technological progress, capital per workers remains constant and economic growth ceases. This point is called a steady state.
The model also notes that countries can overcome this steady state and continue growing by using new technology. In the long run, output per capita depends on the rate of saving, but the rate of output growth is independent of the saving rate. The process by which countries continue growing despite the diminishing returns is "exogenous" and represents the creation of new technology that allows production with fewer resources. Technology improves, the steady state level of capital increases, and the country invests and grows. One important prediction of the model, mostly borne out by the data, is that of "conditional convergence"; the idea that poor countries will grow faster and catch up with rich countries as long as they have similar saving rates and technology.
A major shortcoming of the approach is that it does not explain the sources of technological change.
Endogenous growth theory
Unsatisfied with the assumption of exogenous technological progress in the Solow-Swan model, economists worked to "endogenize" technology in the 1980s. They developed the endogenous growth theory that includes a mathematical explanation of technological advancement. This model also incorporated a new concept of human capital, the skills and knowledge that make workers productive. Unlike physical capital, human capital has increasing rates of return. Research done in this area has focused on what increases human capital (e.g. education) or technological change (e.g. innovation).
Unified growth theory
Unified growth theory was developed by Oded Galor and his co-authors to address the inability of endogenous growth theory to explain key empirical regularities in the growth processes of individual economies and the world economy as a whole. Endogenous growth theory was satisfied with accounting for empirical regularities in the growth process of developed economies over the last hundred years. As a consequence, it was not able to explain the qualitatively different empirical regularities that characterized the growth process over longer time horizons in both developed and less developed economies. Unified growth theories are endogenous growth theories that are consistent with the entire process of development, and in particular the transition from the epoch of Malthusian stagnation that had characterized most of the process of development to the contemporary era of sustained economic growth.
The big push
One popular theory in the 1940s was the Big Push, which suggested that countries needed to jump from one stage of development to another through a virtuous cycle, in which large investments in infrastructure and education coupled with private investments would move the economy to a more productive stage, breaking free from economic paradigms appropriate to a lower productivity stage. The idea was revived and formulated rigorously, in the late 1980s by Kevin Murphy, Andrei Schleifer and Robert Vishny.
Schumpeterian growth is an economic theory named after the 20th-century Austrian economist Joseph Schumpeter. The approach explains growth as a consequence of innovation and a process of creative destruction that captures the dual nature of technological progress: in terms of creation, entrepreneurs introduce new products or processes in the hope that they will enjoy temporary monopoly-like profits as they capture markets. In doing so, they make old technologies or products obsolete. This can be seen as an annulment of previous technologies, which makes them obsolete, and "...destroys the rents generated by previous innovations." (Aghion 855) A major model that illustrates Schumpeterian growth is the Aghion-Howitt model.
Institutions and growth
According to Acemoğlu, Simon Johnson and James Robinson, the positive correlation between high income and cold climate is a by-product of history. Europeans adopted very different colonization policies in different colonies, with different associated institutions. In places where these colonizers faced high mortality rates (e.g., due to the presence of tropical diseases), they could not settle permanently, and they were thus more likely to establish extractive institutions, which persisted after independence; in places where they could settle permanently (e.g. those with temperate climates), they established institutions with this objective in mind and modeled them after those in their European homelands. In these 'neo-Europes' better institutions in turn produced better development outcomes. Thus, although other economists focus on the identity or type of legal system of the colonizers to explain institutions, these authors look at the environmental conditions in the colonies to explain institutions. For instance, former colonies have inherited corrupt governments and geo-political boundaries (set by the colonizers) that are not properly placed regarding the geographical locations of different ethnic groups, creating internal disputes and conflicts that hinder development. In another example, societies that emerged in colonies without solid native populations established better property rights and incentives for long-term investment than those where native populations were large.
Human capital and growth
One ubiquitous element of both theoretical and empirical analyses of economic growth is the role of human capital. The skills of the population enter into both neoclassical and endogenous growth models. The most commonly used measure of human capital is the level of school attainment in a country, building upon the data development of Robert Barro and Jong-Wha Lee. This measure of human capital, however, requires the strong assumption that what is learned in a year of schooling is the same across all countries. It also presumes that human capital is only developed in formal schooling, contrary to the extensive evidence that families, neighborhoods, peers, and health also contribute to the development of human capital. To measure human capital more accurately, Eric Hanushek and Dennis Kimko introduced measures of mathematics and science skills from international assessments into growth analysis. They found that quality of human capital was very significantly related to economic growth. This approach has been extended by a variety of authors, and the evidence indicates that economic growth is very closely related to the cognitive skills of the population.
Energy consumption and growth
Energy economic theories hold that rates of energy consumption and energy efficiency are linked causally to economic growth. A fixed relationship between historical rates of global energy consumption and the historical accumulation of global economic wealth has been observed. Increases in energy efficiency were a portion of the increase in Total factor productivity. Some of the most technologically important innovations in history involved increases in energy efficiency. These include the great improvements in efficiency of conversion of heat to work, the reuse of heat, the reduction in friction and the transmission of power, especially through electrification. "Electricity consumption and economic growth are strongly correlated". "Per capita electric consumption correlates almost perfectly with economic development."
Determinants of per capita GDP growth
Per capita output is determined by: output per unit of labor input (labor productivity), hours worked (intensity), the percentage of the working age population actually working (participation rate) and the proportion of the working-age population to the total population (demography). "The rate of change of GDP/population is the sum of the rates of change of these four variables plus their cross products."
Increases in labor productivity (the ratio of the value of output to labor input) have historically been the most important source of real per capita economic growth. "In a famous estimate, MIT Professor Robert Solow concluded that technological progress has accounted for 80 percent of the long-term rise in U.S. per capita income, with increased investment in capital explaining only the remaining 20 percent."
(Note: There are various measures of productivity. The term used here applies to a broad measure of productivity. By contrast, Total factor productivity (TFP) measures the change in output not attributable to capital and labor. Many of the cited references use TFP.) Increases in productivity lower the real cost of goods. Over the 20th century the real price of many goods fell by over 90%.
The rate of productivity growth in the United States is declining.
Historical sources of productivity growth
Economic growth has traditionally been attributed to the accumulation of human and physical capital, and increased productivity arising from technological innovation.
Before industrialization, technological progress resulted in an increase in population, which was kept in check by food supply and other resources, which acted to limit per capita income, a condition known as the Malthusian trap. The rapid economic growth that occurred during the Industrial Revolution was remarkable because it was in excess of population growth, providing an escape from the Malthusian trap. Countries that industrialized eventually saw their population growth slow down, a phenomenon known as the demographic transition.
Increases in productivity are the major factor responsible for per capita economic growth – this has been especially evident since the mid-19th century. Most of the economic growth in the 20th century was due to reduced inputs of labor, materials, energy, and land per unit of economic output (less input per widget). The balance of growth has come from using more inputs overall because of the growth in output (more widgets or alternately more value added), including new kinds of goods and services (innovations).
During the Industrial Revolution, mechanization began to replace hand methods in manufacturing, and new processes streamlined production of chemicals, iron, steel, and other products. Machine tools made the economical production of metal parts possible, so that parts could be interchangeable. See: Interchangeable parts.
During the Second Industrial Revolution, a major factor of productivity growth was the substitution of inanimate power for human and animal labor. Also there was a great increase power as steam powered electricity generation and internal combustion supplanted limited wind and water power. Since that replacement, the great expansion of total power was driven by continuous improvements in energy conversion efficiency. Other major historical sources of productivity were automation, transportation infrastructures (canals, railroads, and highways), new materials (steel) and power, which includes steam and internal combustion engines and electricity. Other productivity improvements included mechanized agriculture and scientific agriculture including chemical fertilizers and livestock and poultry management, and the Green Revolution. Interchangeable parts made with machine tools powered by electric motors evolved into mass production, which is universally used today.
Great sources of productivity improvement in the late 19th century were railroads, steam ships, horse-pulled reapers and combine harvesters, and steam-powered factories. The invention of processes for making cheap steel were important for many forms of mechanization and transportation. By the late 19th century both prices and weekly work hours fell because less labor, materials, and energy were required to produce and transport goods. However, real wages rose, allowing workers to improve their diet, buy consumer goods and afford better housing.
Mass production of the 1920s created overproduction, which was arguably one of several causes of the Great Depression of the 1930s. Following the Great Depression, economic growth resumed, aided in part by demand for entirely new goods and services, such as telephones, radio, television, automobiles, and household appliances, air conditioning, and commercial aviation (after 1950), creating enough new demand to stabilize the work week. The building of highway infrastructures also contributed to post World War II growth, as did capital investments in manufacturing and chemical industries. The post World War II economy also benefited from the discovery of vast amounts of oil around the world, particularly in the Middle East. By John W. Kendrick’s estimate, three-quarters of increase in U.S. per capita GDP from 1889 to 1957 was due to increased productivity.
Economic growth in the United States slowed down after 1973. In contrast growth in Asia has been strong since then, starting with Japan and spreading to Korea, China, the Indian subcontinent and other parts of Asia. In 1957 South Korea had a lower per capita GDP than Ghana, and by 2008 it was 17 times as high as Ghana's. The Japanese economic growth has slackened considerably since the late 1980s.
Productivity in the United States grew at an increasing rate throughout the 19th century and was most rapid in the early to middle decades of the 20th century. US productivity growth spiked towards the end of the century in 1996–2004, due to an acceleration in the rate of technological innovation known as Moore's law. After 2004 U.S. productivity growth returned to the low levels of 1972-96.
Intensity (hours worked)
As a result of productivity the work week declined considerably over the 19th century. By the 1920s the average work week in the U.S. was 49 hours, but the work week was reduced to 40 hours (after which overtime premium was applied) as part of the National Industrial Recovery Act of 1933.
Demographic factors may influence growth by changing the employment to population ratio and the labor force participation rate. Industrialization creates a demographic transition in which birth rates decline and the average age of the population increases.
Women with fewer children and better access market employment tend to join the labor force in higher percentages. There is a reduced demand for child labor and children spend more years in school. The increase in the percentage of women in the labor force in the U.S. contributed to economic growth, as did the entrance of the baby boomers into the work force. See: Spending wave
Other factors affecting growth
Capital in economics ordinarily refers to physical capital, which consists of structures and equipment used in business (machinery, factory equipment, computers and office equipment, construction equipment, business vehicles, etc.). Up to a point the amount of capital per worker is an important cause of economic output growth. Capital is subject to diminishing returns because of the amount that can be effectively invested and because of the growing burden of depreciation.
In the development of economic theory the distribution of income was considered to be between labor and the owners of land and capital.
In recent decades there have been several Asian countries with high rates of economic growth driven by capital investment.
New products and services
Another major cause of economic growth is the introduction of new products and services and the improvement of existing products. New products create demand, which is necessary to offset the decline in employment that occurs through labor saving technology.
Political institutions, property rights, and rule of law
In economics and economic history, the transition to capitalism from earlier economic systems was enabled by the adoption of government policies that facilitated commerce and gave individuals more personal and economic freedom. These included new laws favorable to the establishment of business, including contract law, the abolishment of anti-usury laws and laws providing for the protection of private property. When property rights are less certain, transaction costs can increase, hindering economic development. Enforcement of contractual rights is necessary for economic development because it determines the rate and direction of investments. When the rule of law is absent or weak, the enforcement of property rights depends on threats of violence, which causes bias against new firms because they can not demonstrate reliability to their customers.
Economic growth in the U.S. and other developed countries went through phases that affected growth through changes in the labor force participation rate and the relative sizes of economic sectors. The transition from an agricultural economy to manufacturing increased the size of the high output per hour, high productivity growth manufacturing sector while reducing the size of the lower output per hour, lower productivity growth agricultural sector. Eventually high productivity growth in manufacturing reduced the sector size as prices fell and employment shrank relative to other sectors. The service and government sectors, where output per hour and productivity growth is very low, saw increases in share of the economy and employment during the 1990s. The public sector has since contracted, while the service economy expanded in the 2000s.
Economists distinguish between short-run economic changes in production and long-run economic growth. Short-run variation in economic growth is termed the business cycle. Generally, economists attribute the ups and downs in the business cycle to fluctuations in aggregate demand. In contrast, economic growth is concerned with the long-run trend in production due to structural causes such as technological growth and factor accumulation.
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Some theories developed in the 1970s suggested possible avenues through which inequality may have a positive effect on economic development. Savings by the wealthy, if these increase with inequality, were thought to offset reduced consumer demand.
Later analysis, such as the political economy approach, developed by Alesina and Rodrik (1994) and Persson and Tabellini (1994), stressed the negative impacts of inequality on economic development; inequality generates a pressure to adopt redistributive policies that have an adverse effect on investment and economic growth. However, empirical tests of an extended version of Alesina and Rodrik's model by Li and Zou found that "income inequality is positively, and most of the time significantly, associated with economic growth".
The credit market imperfection approach, developed by Galor and Zeira (1993), argued that inequality in the presence of credit market imperfections has a long lasting detrimental effect on human capital formation and economic development.
A study by Perotti (1996) showed that in accordance with the credit market imperfection approach, inequality is associated with lower level of human capital formation (education, experience, apprenticeship) and higher level of fertility, while lower level of human capital is associated with lower growth and lower levels of economic growth. In contrast, his examination of the political economy channel found no support for the political economy mechanism.
A 1999 review in the Journal of Economic Literature stated that high inequality lowers growth, perhaps because it increases social and political instability; however, changes in the degree of inequality have a relatively minor effect on growth.
Research by Harvard economist Robert Barro, found that there is "little overall relation between income inequality and rates of growth and investment". According to Barro, high levels of inequality reduce growth in relatively poor countries but encourage growth in richer countries. Princeton economist Roland Benabou's research shows that inequality does not matter per se to growth, but "inequality in the relative distribution of earnings and political power" does matter.
According to Andrew Berg and Jonathan Ostry (2011) of the International Monetary Fund, inequality in wealth and income is negatively correlated with subsequent economic growth. Likewise, economists Dierk Herzer and Sebastian Vollmer found that increased income inequality reduces economic growth, but growth itself also increases income inequality in the long run.
While acknowledging the central role economic growth can potentially play in human development, poverty reduction and the achievement of the Millennium Development Goals, it is becoming widely understood amongst the development community that special efforts must be made to ensure poorer sections of society are able to participate in economic growth. The effect of economic growth on poverty reduction - the growth elasticity of poverty - can depend on the existing level of inequality. For instance, with low inequality a country with a growth rate of 2% per head and 40% of its population living in poverty, can halve poverty in ten years, but a country with high inequality would take nearly 60 years to achieve the same reduction. In the words of the Secretary General of the United Nations Ban Ki-Moon: "While economic growth is necessary, it is not sufficient for progress on reducing poverty."
Environmental and physical constraints
While environmental and physical constraints may limit economic growth, resource depletion has in the past been addressed by technical advances and substitution.
Critics such as the Club of Rome argue that a narrow view of economic growth, combined with globalization, is creating a scenario where we could see a systemic collapse of our planet's natural resources.
Concerns about possible negative effects of growth on the environment and society led some to advocate lower levels of growth. This led to the ideas of uneconomic growth and de-growth – and Green parties that argue that economies are part of a global society and global ecology, and cannot outstrip their natural growth without damaging those.
Those more optimistic about the environmental impacts of growth believe that, though localized environmental effects may occur, large-scale ecological effects are minor. The argument, as stated by commentator Julian Lincoln Simon, states that if these global-scale ecological effects exist, human ingenuity will find ways to adapt to them.
Up to the present, there is a close correlation between economic growth and the rate of carbon dioxide emissions across nations, although there is also a considerable divergence in carbon intensity (carbon emissions per GDP). Up to the present, there is also a direct relation between global economic wealth and the rate of global emissions. The Stern Review notes that the prediction that, "Under business as usual, global emissions will be sufficient to propel greenhouse gas concentrations to over 550ppm CO2 by 2050 and over 650–700ppm by the end of this century is robust to a wide range of changes in model assumptions." The scientific consensus is that planetary ecosystem functioning without incurring dangerous risks requires stabilization at 450–550 ppm.
As a consequence, growth-oriented environmental economists propose government intervention into switching sources of energy production, favouring wind, solar, hydroelectric, and nuclear. This would largely confine use of fossil fuels to either domestic cooking needs (such as for kerosene burners) or where carbon capture and storage technology can be cost-effective and reliable. The Stern Review, published by the United Kingdom Government in 2006, concluded that an investment of 1% of GDP (later changed to 2%) would be sufficient to avoid the worst effects of climate change, and that failure to do so could risk climate-related costs equal to 20% of GDP. Because carbon capture and storage is as yet widely unproven, and its long term effectiveness (such as in containing carbon dioxide 'leaks') unknown, and because of current costs of alternative fuels, these policy responses largely rest on faith of technological change.
On the other hand, British conservative politician and journalist Nigel Lawson claimed that people in a hundred years' time would be "seven times as well off as we are today", therefore it is not reasonable to impose sacrifices on the "much poorer present generation".
Many earlier predictions of resource depletion, such as Thomas Malthus' 1798 predictions about approaching famines in Europe, The Population Bomb (1968), and the Simon–Ehrlich wager (1980)  have not materialized. Diminished production of most resources has not occurred so far, one reason being that advancements in technology and science have allowed some previously unavailable resources to be produced. In some cases, substitution of more abundant materials, such as plastics for cast metals, lowered growth of usage for some metals. In the case of the limited resource of land, famine was relieved firstly by the revolution in transportation caused by railroads and steam ships, and later by the Green Revolution and chemical fertilizers, especially the Haber process for ammonia synthesis. In the case of minerals, lower grades of mineral resources are being extracted, requiring higher inputs of capital and energy for both extraction and processing. An example is natural gas from shale and other low permeability rock, which can be developed with much higher inputs of energy, capital, and materials than conventional gas in previous decades. Another example is offshore oil and gas, which has exponentially increasing cost as water depth increases.
Some physical scientists like Al Bartlett regard continuous economic growth as unsustainable. Several factors may constrain economic growth - for example: finite, peaked, or depleted resources.
Malthusians such as William R. Catton, Jr. are skeptical of technological advances that improve resource availability. Such advances and increases in efficiency, they suggest, merely accelerate the drawing down of finite resources. Catton claims that increasing rates of resource extraction are "...stealing ravenously from the future".
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The U.S. economy achieved a growth rate of labour productivity of 2.48 per cent per year for 81 years, followed by 24 years of 1.32 per cent, then a temporary recovery back to 2.48 per cent per cent, and a final slowdown to 1.35 per cent. The similarity of the growth rates in 1891-1972 with 1996-2004, and of 1972-96 with 1996-2011 is quite remarkable.
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Articles and lectures
- "Economic growth." Encyclopædia Britannic. 2007. Encyclopædia Britannica Online. 17 November 2007.
- Beyond Classical and Keynesian Macroeconomic Policy. Paul Romer's plain-English explanation of endogenous growth theory.
- Does Economic Growth increase Living Standards?
- CEPR Economics Seminar Series Two seminars on the importance of growth with economists Dean Baker and Mark Weisbrot
- On global economic history by Jan Luiten van Zanden. Explores the idea of the inevitability of the Industrial Revolution.
- The Economist Has No Clothes – essay by Robert Nadeau in Scientific American on the basic assumptions behind current economic theory
- World Growth Institute. An organization dedicated to helping the developing world realize its full potential via economic growth.
- Economics for Everyone- Evaluating Economic Growth
- Understanding the world today Multiple reports on economic growth
- Research and Degrowth network Academic association dedicated to research, awareness raising, and events organization around the topic of degrowth.
- Angus Maddison's Historical Dataseries – Series for almost all countries on GDP, Population and GDP per capita from the year 0 up to 2003
- OECD Economic growth statistics
- multinational data sets easy to use data set showing gdp, per capita and population, by country and region, 1970 to 2008. Updated regularly.