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Economic Growth

Asked by sweet_gurl | Feb 20, 2007 | A Level > Economics > Homework
sweet_gurl asks:

Evaluate the consequences of a sustained, high rate of economic growth.

etutor answers:

Economic Growth has two meanings. First, it refers to the annual increase in real Gross Domestic Product - in other words, the increase in the value of goods and services produced in the domestic economy, after allowing for inflation (hence the 'real'). Second, it refers to an increase in the CAPACITY of an economy to produce goods and services - in other words, an outward movement of its production possibility frontier. In this particular case, it is a reference to the first of these; a high and sustained increase in real GDP, year after year.

There are several benefits of growth, including:

  • The increase in production of goods and services adds directly to living standards, since more goods and services are now available for domestic consumption. 
  • In normal circumstances, increased output means that some firms will need to recruit more labour; this increases the level of employment and reduces the level of unemployment.
  • Growth means there are more goods and services available for export to other countries; this improves the country's balance of payments, and also means it earns the foreign currency that enables it to afford a greater quantity and range of imports.
  • Growth leads to a rise in incomes (wages and the profits of firms) and a rise in spending on goods and services. This means that the government automatically receives an increase in tax revenues, from income tax, corporation tax, VAT and excise duties. This enables it to finance additional spending on public services such as health, education and transport, all of which further increases living standards, and improves the infrastructure of the economy, making production more efficient, and thus more competitive. The government's spending on unemployment and related benefits will also fall.
  • If the increase in growth comes about through greater investment by firms, this means that the productive capacity of the economy is increased, leading to more efficient production, and the development of new products, all of which reduces prices to consumers, increases their living standards, and provides them with a wider range of products and services.

Very high growth rates do, however, pose a number of potential problems, including:

  • They are normally associated with rapidly rising aggregate demand; if the rise in AD exceeds the growth of output then the outcome will be greater demand pull inflation. This in turn makes domestic output increasingly price uncompetitive, and can ultimately result in falling sales at home and abroad, the closure of firms and rising unemployment.
  • The demand pull inflation may also precipitate demands for higher pay to compensate; if these are conceded, then the result will be a wage-price spiral, with wages and prices chasing each other upwards; this reinforces the effect on competitiveness described above. 
  • If the effect of the above is to reduce export sales and to increase (relatively cheaper) import purchases, this in turn worsens the trade balance and causes a fall in the exchange rate, which then causes imported inflation - this was the UK experience in the 1970s.
  • The central bank will almost certainly react to rising inflation by raising interest rates, to reduce the level of AD; the effect of this is to slow down growth, sometimes to the point of causing the economy to enter a recession.
  • High levels of growth can have detrimental environmental effects, in terms of increased congestion, pollution and resource depletion; this places a burden on both present and future generations.
  • Not all citizens share the fruits of growth, particularly those in low income industries and those out of work; if (as is usual) the engine of growth is highly paid service and hi-tech industries, then there will be an increase in income inequality, which may lead to social tensions.

I hope this is helpful.

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