The term of economic growth. Four key elements of economic growth by Simon Kuznets. Benefits from growth driven by technological change. Economic and social costs from rising inequality. Advantages, disadvantages and forecasts of economic growth.
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- 1. Economic growth: costs and benefits
- 1.1 The term of economic growth
- 1.2 Advantages of economic growth
- 1.3 Disadvantages of Economic Growth
- 1.4 Economic Growth and Income and Wealth Inequality
- 2. Overview of economic growth
- 2.1 Economic and Social Costs from Rising Inequality
- 2.2 Forecasts of Economic Growth
economic growth technological kuznets
In recent years many countries, such as Brazil, India and china are rapidly developing and are experiencing a very high level of economic growth, while economic growth has its many benefits, to both the government and the general population, it also has several considerable negative impacts in the long term, which could lead to an unstable economy in the future if it is mismanaged.
1. Economic growth: costs and benefits
1.1 The term of economic growth
Economic growth is defined as the sustained increase in real GDP or GNP per capita over time. Economic growth is desirable for an economy as it increases its real national income and standards of living for its people in general. Although it is desirable, economic growth does have its benefits and costs.
Simon Smith Kuznets (a Belarusian-American economist, statistician, demographer, and economic historian) proposed research program that involved extensive empirical studies on the four key elements of economic growth (see picture No.1). In fact, the demographic growth, the growth of knowledge, in-country adaptation to growth factors and external economic relations between the countries. The general theory of economic growth should explain the development of advanced industrial countries, and the reasons that prevent the development of backward countries, include both market and planned economies, large and small, developed and developing countries, consider the impact on growth of foreign economic relations.
Picture No.1. 4 Key elements of economic growth by Simon Kuznets.
He collected and analyzed statistical indicators of economic performance of 14 countries in Europe, the U.S. and Japan for 60 years. Analysis of the materials led to the advancement of a number of hypotheses relating to various aspects of the mechanism of economic growth, concerning the level and variability of growth, structure of the GNP and distribution of labor, the distribution of income between households, the structure of foreign trade. Kuznets founded the historically grounded theory of economic growth. The central theme of these empirical studies is that the growth of the aggregated product of the country necessarily implies a profound transformation of the whole of its economic structure. This transformation affects many aspects of economic life - the structure of production, sectorial and occupational structure of employment, the division of occupations among family and market activities, the income structure, size, age structure and spatial distribution of the population, cross-country flows of goods, capital, labor and knowledge, the organization of industry and governmental regulation. Such changes, in his opinion, are essential for overall growth and, once started, shape, constrain or support the subsequent economic development of the country. Kuznets made a profound analysis of the impact on economic growth by demographic processes and characteristics.
His major thesis, which argued that underdeveloped countries of today possess characteristics different from those that industrialized countries faced before they developed, helped put an end to the simplistic view that all countries went through the same "linear stages" in their history and launched the separate field of development economics - which now focused on the analysis of modern underdeveloped countries' distinct experiences.
1.2 Advantages of economic growth
Growth has a number of economic and social benefits:
- improvements in living standards: growth is an important avenue through which per capita incomes can rise and absolute poverty can be reduced in developing nations. Professor Paul Collier has argued that "growth is not a cure-all; but the absence of growth is a kill-all";
- more jobs: growth creates new jobs - although the pattern of employment will also change;
- the accelerator effect of growth on capital investment: rising demand and output encourages investment in capital - this helps to sustain GDP growth by increasing LRAS;
- greater business confidence: growth has a positive impact on profits & business confidence;
- the "fiscal dividend": A growing economy boosts tax revenues and generates the money to finance spending on public and merit goods and services without having to raise tax rates;
- potential environmental benefits - as countries grow richer, they have more resources available to invest in cleaner technologies. And, as nations develop, energy intensity levels fall (see picture no.2).
Picture no.2. Benefits from growth driven by technological change
1.3 Disadvantages of Economic Growth
There are economic and social costs of a fast-expanding economy.
Inflation risk: If demand races ahead of aggregate supply the scene is set for rising prices - many of the faster-growing countries have seen a trend rise in inflation - this is known as structural inflation.
- fast growth can create negative externalities for example more noise pollution and lower air quality arising from air pollution and road congestion;
- increased consumption of de-merit goods which damage social welfare;
- the huge increase in household and industrial waste. These externalities reduce social welfare and can lead to market failure.
Growth that leads to environmental damage may lower the sustainable rate of growth. Examples include the destruction of rain forests through deforestation, the over-exploitation of fish stocks and loss of natural habitat and bio-diversity created through the construction of new roads, hotels, retail malls and industrial estates.
Many of the world's most valuable finite resources are being extracted at such a rate that it questions the sustainability of growth. Renewable resources are also being depleted because of over-consumption.
Examples include the destruction of rain forests, the over-exploitation of fish stocks and loss of natural habitat created through the construction of new roads, hotels, retail malls and industrial estates. Some of the main environmental threats include:
- the depletion of the global resource base and the impact of global warming. There are plenty of examples of the "tragedy of the commons"; the permanent loss of what should be renewable resources from over-extraction of some of our environmental resources;
- a huge expansion of waste and pollution arising from both production and consumption;
- over-population (particularly in urban areas) putting increased pressure on scarce land and other resources. More than half of the world's population lives in cities in 2009, most of them in developing countries according to the United Nations Population Fund;
- species extinction leading to a loss of bio-diversity - Scientists predict that at least a third and as much as two-thirds of the world's species could be on their way to extinction by the end of this century, mostly because people are destroying tropical forests and other habitats, over-fishing the oceans and changing the global climate.
1.4 Economic Growth and Income and Wealth Inequality
Not all of the benefits of growth are evenly distributed. A rise in real GDP can often be accompanied by widening income and wealth inequality in society that is reflected in an increase in relative poverty.
The Gini coefficient is one way to measure the inequalities in the distribution of income and wealth in different countries. The higher the value for the Gini coefficient (the maximum value is 1), then greater the inequality. Countries such as Japan, Denmark and Sweden typically have low values for the Gini coefficients whereas African and South American countries have an enormous gulf between the incomes of the richest and the poorest elements of the population.
When economists look at data on income and income inequality they nearly always focus on median rather than mean incomes per capita. The reason is that the very uneven distribution of income means that there are people who earn astounding salaries and wages and the income of the super-rich tends to drive up mean incomes. For example, In the United States, mean income is almost a third higher than median income, and the gap is growing. This was a factor behind the rise to prominence of the Occupy protest movement in the USA.
Why can rapid growth often lead to a widening of inequalities in both developed and developing countries?
1. High increases in pay of people in top-paying jobs.
2. Increasing wealth including rising property prices.
3. Growing gaps between urban and rural areas.
4. High fertility in poorer households.
5. Increasing pay of those with higher levels of schooling especially with the growth of jobs and pay in high-knowledge industries such as computer gaming, engineering systems, financial trading.
6. Reductions in the percentage of people who are members of a trade union.
7. Linked effects of inequality in health and education.
Much depends on the extent to which a government has a welfare and tax system in place to provide an income safety-net and also a desire to redistribute rising incomes and wealth so that the benefits of growth can be more equitably shared out.
2. Overview of economic growth
2.1 Economic and Social Costs from Rising Inequality
In 1980, the per capita income of the 15 richest nations was 44 times that of the 15 poorest, by 2000, that multiple had increased to 62. However in 2013, reflecting better economic performance in several developing and transition countries; the ratio had fallen to 56.
The Kuznets Curve was established by the economist Simon Kuznets and it dates from the 1950s.
It suggests that in preindustrial societies, almost everybody is equally poor so inequality is low. Inequality then rises as people move from low-productivity agriculture to the more productive industrial sector, where average income is higher and wages are less uniform.
As a society develops and becomes richer, the urban-rural gap is reduced and old-age pensions, unemployment benefits, and other components of a social safety net have the effect of lowering inequality. The shape of a possible Kuznets Curve is shown in the diagram no.1.
Diagram no.1. The shape of Kuznets Curve.
Trends over the last 30 years show income inequality increasing within countries and between them.
For emerging countries, inequality has risen in most countries - suggesting that many nations have been on the rising part of the curve. Of the BRIC countries and other leading developing countries, only Brazil has seen an eventual fall in measured income inequality. Partly this is the result of deliberate inclusive growth policies including the conditional cash transfer policy.
We can see from the table below the depth of the scale of income inequality in some low and low-middle income countries. In South Africa 84% of cumulative income is held by the richest 40% of the population whereas the poorest fifth take just 3% of income. (see table no.1).
Table no.1. The depth of the scale of income inequality
2.2 Forecasts of Economic Growth
Europe's economic recovery, which began in the second quarter of 2013, is expected to continue spreading across countries and gaining strength while at the same time becoming more balanced across growth drivers. As it is typical following deep financial crises, however, the recovery remains fragile.
Nevertheless, recent positive economic news means that the forecasts for GDP growth this year and next have been raised slightly since the autumn. EU GDP, which rose 0.1% in 2013, is now expected to rise 1.5% this year and 2.0% next year, while growth in the euro area, which was - 0.4% for 2013 as a whole, is expected to be 1.2% in 2014 and 1.8% in 2015. After two years of contraction, domestic demand is gently firming, as the crisis' legacy of excessive debt, financial fragmentation, economic uncertainty and the need for adjustment and fiscal consolidation fades, and confidence is improving. The fiscal stances of the EU and euro area this year are expected to be broadly neutral. At the same time, rising import demand means that external trade's contribution to growth will become more muted. In line with these developments, unemployment should fall slightly from its peak, as the labor market turns the corner. The forecast for inflation in the EU and the euro area has been lowered significantly since the autumn. Inflation in the EU is now expected to dip to 1.2% in 2014 before rising again to 1.5% in 2015. In the euro area, inflation is seen at 1.0% in 2014 and 1.3% in 2015.
The world economy picked up in the second half of last year, driven by stronger growth in advanced economies, especially in the US, but also by a rebound in some emerging market economies. Growth is expected to accelerate for most advanced economies outside the EU. In the US where the headwinds from fiscal policy have been waning, private consumption is gaining speed benefitting from robust job creation and rising house prices, while the Federal Reserve has initiated a gradual shift towards less accommodative monetary policy. In Japan, growth is expected to remain relatively stable in 2014. Among emerging market economies, the picture is uneven. There are continued signs of weakness in Russia and Brazil, some stabilization at more sustainable growth rates in China and an improved outlook for India. Recent financial tensions have so far mostly affected emerging markets with relatively weak macroeconomic fundamentals, such as Argentina, Turkey and South Africa, while the EU Member States have been largely spared so far.
After lackluster 2013, economic activity outside the EU is expected to accelerate to about 4% this year and 4Ѕ% in 2015. Global trade is forecast to rise more than GDP, with world import growth doubling from 2Ѕ% in 2013 to about 5% in 2014 and rising to 6% in 2015, reflecting both the strengthening of the global recovery and the impetus from trade-intensive sectors. Over the forecast horizon, oil prices are forecast to continue declining along the same path as assumed in November, supported by adequate supply. The nominal exchange rate of the euro against main trading partners (based on the technical assumption of unchanged nominal exchange rates) is now projected about 2% higher than last autumn.
The recovery in Europe is expected to be broad-based across EU Member States as activity has also started to strengthen in the vulnerable countries of the euro-area periphery. Growth differentials persist but the gap is projected to narrow. In 2014, only Cyprus and Slovenia are still expected to register negative annual GDP growth rates. By 2015 all EU economies are expected to be growing again. Internal and external adjustment in vulnerable Member States is progressing, underpinned in many cases by significant structural reforms that are starting bearing fruit. Ireland has successfully completed its financial assistance program in December 2013. Driven by strong exports, growth is significantly firming in Spain and Portugal, while a moderate rebound is expected in Greece. Among the bigger economies, a steady domestic demand-driven expansion is expected over the forecast horizon in Germany, while in France economic growth is only slowly recovering, supported by a timid pick up in private consumption. Mild economic recoveries in the Netherlands and in Italy are set to be driven by net exports and investment. Strong growth is foreseen in the United Kingdom and in Poland on the back of increasingly robust domestic demand.
The rebalancing of Europe's growth engines is confirmed as domestic demand overtakes exports as main thruster. The strengthening of domestic demand, though still expected to be modest in 2014, will be fuelled by all components, both private and public.
Investment growth, in particular investment in equipment, is projected to significantly strengthen, as the main impediments to firms' demand and profits (uncertainty, financing conditions, deleveraging needs) are slowly receding, and the improvement in the economic outlook is confirmed. Uncertainty has significantly receded over the past year and a half and should continue to do so under the assumption of smooth policy implementation at the EU and Member-State levels. Financing conditions are also expected to improve and to support further investment spending.
Private consumption showed only marginal growth at the onset of the recovery but is expected to gain momentum over 2014-2015, as the labor market slightly improves, real disposable incomes benefits from low consumer price inflation and the drag of fiscal consolidation diminishes. In line with improved confidence and lower precautionary savings, households are expected to spend most of the increase in real income. Public consumption is also expected to pick up as fiscal consolidation needs become less acute.
The current-account surpluses of both the EU and the euro area increased in 2013 and are expected to remain broadly stable (at respectively 1Ѕ% and 2ј% of GDP) this year and next. Most of the recent strengthening is the result of significant adjustment, involving improved exports but also a largely permanent contraction in domestic demand, in the euro-area Member States that previously recorded high deficits. This external rebalancing is supported by enhanced price competitiveness resulting from lower unit labour costs. High external indebtedness, however, requires the external adjustment in some Member States to go further still.
Financial market conditions in the EU improved in 2013, as a result of the better macroeconomic outlook and sustained low-interest rate environment. Financial fragmentation considerably receded in the sovereign- and corporate-debt markets, with most bond spreads of vulnerable Member States continuing to narrow, thanks to investor confidence in the success of the ongoing fiscal adjustment and economic reforms. However, despite some normalization in bank funding conditions, financial fragmentation on the euro-area lending market continues to impair the transmission of monetary policy, hurting mainly small and medium-sized enterprises. The ECB's comprehensive assessment of banks' balance sheets and a smooth implementation of the Banking Union should further reinforce confidence in European banks and fan the recovery.
Substantial improvements in public finances have been achieved in the EU since 2011. On the basis of policy measures already approved by national parliaments or known with sufficient detail, the fiscal stance is expected to be close to neutral over the forecast horizon. The fiscal effort this year, measured in terms of change of the structural balance, is indeed expected to be broadly neutral in the EU and in the euro area. At the same time, fiscal consolidation is expected to move gradually from revenue measures to expenditure control. Headline fiscal deficits are set to shrink further in 2014 (to around 2ѕ% of GDP in the EU and 2Ѕ% of GDP in the euro area) before stabilizing in 2015 under the assumption of no policy change. The debt-to GDP ratio is expected to peak in 2014 at 90% in the EU and at 96% in the euro area.
Labor market conditions stabilized in mid-2013 but only a small improvement is expected in 2014 and 2015 because labor markets typically react with a certain lag to rebounds in economic activity and the recovery remains modest. In the early phase of the recovery, private employment growth is expected to be dampened by the usual adjustment in working hours. Decisive structural reforms implemented in some Member States may shorten this period and help prevent the very high level of unemployment from becoming structural. Employment in the EU and the euro area is expected to start rising modestly in 2014 by Ѕ% and about ј% respectively, slightly better than projected last autumn. This increase will not yet be sufficient to meaningfully curb unemployment in the EU, but it will trigger a stabilization of the unemployment rate in the euro area. In 2015, employment growth is set to accelerate to ѕ% in both areas, resulting in a slight reduction of unemployment to 10.4% in the EU and 11.7% in the euro area. Labor markets will continue to perform differently across Member States.
Headline inflation decreased markedly over the course of 2013, particularly in the last quarter of the year, due to falling energy and commodity prices, weak demand, the fading impact of some temporary factors, and the continued appreciation of the euro. The expectation that the output gap will close only slowly suggests that weak demand will continue to contribute to low inflation. Subdued pressures are expected to keep consumer price inflation down to 1.2% in the EU and 1.0% in euro area in 2014. Only a slight increase is expected for 2015 when economic growth gains momentum. Low inflation is expected to support private consumption because it boosts real disposable incomes. However, since inflation expectations have been sagging, real interest rates have actually risen since the autumn. Moreover, low aggregate inflation makes it harder for vulnerable countries to gain price competitiveness and increases the real value of both public and private debts.
Risks to the growth outlook have become slightly more balanced, but still weigh more heavily on the downside. The main risk to the forecast would be stalling or partial implementation of structural, fiscal and institutional reforms at Member States or European level, resulting in low actual and potential growth and protracted high unemployment. A weaker than projected labor market would have both short- and medium-term detrimental effects on private consumption and also on potential growth. Moreover, the debt overhang, the investment shortfall in recent years and slowing total factor productivity could hurt growth in the medium term if they are inadequately addressed by structural reforms, resulting in an extended period of low growth. The risk of low growth would be exacerbated in the short term by lower than expected inflation and a slower reduction in financial fragmentation.
Inflation could turn out lower than the current forecast if economic agents were to perceive the current very weak price pressures as becoming entrenched. Lower inflation would increase real interest rates with negative effects on growth and on the real debt burden. However, confidence is rising and growth is picking up so there is only a marginal probability of shocks large enough to initiate outright EU or euro-area wide deflation.
Credit growth could remain anemic if the implementation of the Banking Union and the Asset Quality Review (AQR) and stress tests were to fail to clean up balance sheets and restore confidence, also given the still elevated deleveraging needs in the private sector. The resulting prolonged weakness of credit supply would impose a limit on the recovery of investment. Downside risks could also stem from heightened financial instability in emerging markets.
The recovery could also be stronger than envisaged if firmer domestic demand in the core countries helps further the rebalancing process, while the competitiveness boost in peripheral countries is larger than envisaged. In the medium-term, the implementation of additional and bold structural reforms could lift further the potential growth of Member States, with positive impact also in the short-term, notably through increased confidence. Positive confidence effects could lead to a stronger rebound of investment in particular if financial fragmentation is reduced to a greater extent following a successful AQR and the introduction of the Single Supervisory Mechanism.
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