As a slightly fuller definition,
economic growth is the change in
GDP. This is a bit different from
per capita GDP, though per capita GDP is what many people are most interested in, as it is a measurement of
living standards within an economy. The reason we talk about the
change in potential GDP, as opposed to its growth, is that economic growth can be negative in some instances.
Economic growth is affected by changes in
factor supplies and by changes in
factor productivity. Factors include
labour,
physical capital (such as
factories and
machines) and
human capital (such as
education and
on-the-job training). Some economists would argue
technology is also a relevant factor, and of these some would include technology in human capital. Factor productivity (which is the
ouput per unit of
factor input).
Traditional theories of economic growth tend to emphasise the role of changes in factor supplies.
Neo-Classical economists have provided most of what we recognise in
modern growth theory. They believe that the ultimate
determinant of economic growth is
population growth, which is
exogenous (in that
government policies are to all intents and purposes unable to affect it). Neo-Classical theory states that increases in a single factor input will increase economic growth but with
diminishing returns (that is, by an increasingly small amount) because after a while there is, for instance, only so much that extra labourers can add to the economy if there are only twenty
factories. If, on the other hand, factors increase together, then economic growth will be
constant.
In relation to per capita GDP, Neo-Classical theory states that an increase in labour will produce
diminishing per capita GDP, because more labourers are adding relatively less and thus the wages paid to all will go down. If, on the other hand, physical capital increases above labour then there is no reason why per capita GDP should increase. If all factors increase at a
constant rate, then per capita GDP will increase at a constant rate. Neo-Classical theory is quite
depressing, because it implies that it is difficult for living standards to decrease and, in relation to general economic growth it implies that in the long run economic growth will slow down and may even halt if factor inputs increase unevenly. Because economic growth is largely the result of
exogenous factors on this theory, it also means there's very little we can do about it. Bugger.
But, have no fear, the
Neo-Classicists missed something out! They did not take into account the input of
technological change, which largely affects factor productivity.
Robert Solow, in his
growth theory established that technology was the most important
factor in economic growth. It increases growth by allowing us to produce the same amount of output with fewer factor inputs - for example, through machines - and often by completely altering
the way we live, for example with cars and
improved communications. As pointed out by
Lipsey and Chrystal, the economy isn't better off now because we use make more
Victorian commodities with more
Victorian factories. It has grown because
we do things differently and
more efficiently. (
Lipsey and Chrystal,
Principles of Economics p.553 (9th edition. Oxford, OUP. 1999))
Governments generally believe that they can affect economic growth. Policies which aim at factor input increases have largely been ineffective, for the reasons given by the Neo-Classical economists. However, government can give incentives to
firms to
invest in
research and development (
R & D), by
cutting taxes on these areas, or by giving
grants. Thus, with the input of technology, there is room for
optimism in the theory of economic growth. However, this is still a very uncertain field, with people unsure of the relative
effectiveness of any single
factor, such as education or
R & D incentives.
It is also worth saying that some people see economic growth as undesirable, because as economies grow, they use more and more, often
unrenewable resources, thus draining our planet. They sometimes also emphasise the need to concentrate on other goals, such as
equitable redistribution (though those in favour of economic growth argue that with a larger economy it is easier to help the less well-off, because they can
redistribute without the richer people losing any money). One of the key problems with economic growth is that it often lead to increased
pollution. However, one of the inputs of technology is relatively to reduce
pollution, which hopefully will be a
continuing trend in the growth of our economies.