The productive capacity of most economies increases each year. In industrialised economies this is due mainly to improvements in educational standards and advances in technology. In some developing economies it is also due to rises in the size of the labour force. We can predict how much the economy will rise. This is called the trend growth. The trend growth is the expected increase in potential output over time and is a measure of how fast the economy can grow without generating higher inflation. In the United Kingdom’s macroeconomic objectives, economic growth is desired. The government has a target of 2% economic growth per annum.
The graph above shows the change in real GDP for the UK since 1955. There have been three main economic recessions over the last thirty years (1974-75, 1980-81 and 1990-92) but over the long run real output has increased on average by a little over 2% per year. Therefore we can see that the government often succeeds in this objective.
Rich economies, such as the UK generally grow at a more rapid rate than poor economies, although some developing economies are growing rapidly and are narrowing the gap between their real GDP and that of industrialised economies. There are a number of reasons for the differences that exist between countries’ economic growth rates. One I differences in expenditure on investment. Poor countries have low incomes; therefore their people are not able to save much. This reduces the funds and resources available for investment. The resources devoted to education and training also differ. In poor countries very few people go on to higher education, and in some countries, the majority of children do not receive secondary education.
The main benefit of economic growth is likely to be a rise in people’s material standard of living. Economic growth enables poverty to be reduced without having to redistribute existing income. It may create a large number of jobs that will help to reduce unemployment rates. Higher income also raises government tax revenue without having to increase tax rates. Some of this can be use to finance schemes to help the poor, improve public services and improve the environment. Economic growth helps to stimulate higher employment, as labour is a derived demand. An increase in real GDP should cause an outward shift in the aggregate demand for labour. Not all industries will share in the growth of an economy. Economic growth has a positive effect on the Government’s finances. With more people in work and the rising in profits and spending, the Treasury receives an increased flow of revenue. Economic growth is good for general growth and investment, as rising demand and output encourages further investment in new capital machinery via the accelerator mechanism. Also, the economic growth will bring confidence to companies, encouraging more people to invest more money into their businesses.
However, economic growth can also generate costs. In the short run, if the economy is operating at its productive capacity, there will be an opportunity cost in raising production, some resources will have to be switched from making consumer goods to making capital goods. If economic growth is achieved in a way that is not sustainable, for instance in a way that causes pollution, there will be damage to the environment. There is also the risk that economic growth may result in depletion of non-renewable resources and increased stress caused by rapid change, resulting in negative externalities. Economic growth may require people to work much longer hours so that although they might be materially better off, their standards of living may have got worse due to a lack of leisure time. Fast growth may lead to a large increase in the volume of imports that we purchase, producing trade deficit problems. If economic growth rises to quickly, and accelerates out of hand, then there is risk of inflation, as the demand would race ahead of the ability of the economy to supply goods and services.
There are a number of advantages and disadvantages for economic growth, but I believe that if the rate of economic growth were kept under control, then the costs would exceed the benefits. Economic growth can produce damage to the environment, and can use up non-renewable resources, and if the rate of inflation is out of control then inflation is a possibility; but I do think that the advantages of lowering unemployment rates, creating corporate confidence, encouraging investment and creating money to finance government schemes outweigh these disadvantages.