2.5.1 Causes of Economic Growth

This study note for Edexcel economics covers Causes of Economic Growth

Causes of Growth

a) Factors Which Could Cause Economic Growth

Economic growth refers to an increase in the output of goods and services in an economy over time. Various factors can contribute to economic growth:

• Capital Investment: Increased investment in physical capital (machinery, infrastructure) enhances productivity and output.
  • Example: Building new factories and upgrading transportation networks.
• Technological Advancements: Innovations and improvements in technology increase production efficiency and create new products.
  • Example: The rise of information technology boosting productivity in various sectors.
• Human Capital Development: Education and training improve workers' skills and productivity.
  • Example: Investment in higher education and vocational training programs.
• Natural Resources: Discovery and exploitation of natural resources can fuel growth.
  • Example: Oil discoveries in Saudi Arabia leading to rapid economic growth.
• Government Policies: Supportive fiscal and monetary policies, such as tax incentives and low interest rates, encourage investment and spending.
  • Example: Tax cuts to stimulate business investments.
• Institutional Factors: Strong legal and regulatory frameworks, property rights, and political stability promote growth.
  • Example: Stable political environments attract foreign investment.
• Population Growth: A growing population increases the labor force and consumer base.
  • Example: Increased immigration leading to a larger workforce.

b) The Distinction Between Actual and Potential Growth

Actual Growth:

• Refers to the increase in real GDP over time, representing the economy’s current performance.
• It is measured by observing changes in output and is influenced by demand-side factors.
  • Example: A country’s GDP grows from $1 trillion to $1.1 trillion over a year.

Potential Growth:

• Refers to the increase in an economy’s capacity to produce goods and services, reflecting the long-term productive potential.
• It is influenced by supply-side factors like improvements in technology, labor, and capital.
  • Example: An economy’s potential output increases due to technological advancements.

Key Differences:

• Measurement: Actual growth is observed in real-time changes in GDP, while potential growth is an estimate of the economy’s capacity.
• Influences: Actual growth is influenced by short-term factors (demand), whereas potential growth is driven by long-term factors (supply).

c) The Importance of International Trade for (Export-Led) Economic Growth

Export-Led Growth:

• International trade, particularly exports, can significantly drive economic growth.
• Increased Market Size: Access to larger international markets allows firms to achieve economies of scale.
  • Example: Germany’s automobile industry exports cars globally, benefiting from larger production scales.
• Foreign Exchange Earnings: Exports bring in foreign currency, enabling countries to import goods and services they cannot produce efficiently.
  • Example: South Korea exports electronics, earning foreign currency to import oil.
• Technology Transfer: Exposure to international markets and competition can lead to the adoption of new technologies and practices.
  • Example: Chinese firms adopting advanced manufacturing techniques from foreign partners.
• Job Creation: Export industries create jobs, reducing unemployment and boosting incomes.
  • Example: Bangladesh’s textile industry employs millions due to export demand.

Real-World Example:

• The rapid economic growth of East Asian countries (e.g., China, South Korea) in the late 20th and early 21st centuries was largely driven by export-led strategies, focusing on producing goods for international markets.

Glossary

• Capital Investment: Expenditure on physical assets like machinery, infrastructure, and buildings to increase production capacity.
• Human Capital: The skills, knowledge, and experience possessed by individuals, viewed in terms of their value to an organization or economy.
• Real GDP: Gross Domestic Product adjusted for inflation, reflecting the true value of goods and services produced.
• Potential Output: The highest level of economic output that can be sustained over the long term without increasing inflation.
• Economies of Scale: Cost advantages that firms obtain due to the scale of their operations, with cost per unit of output generally decreasing as scale increases.
• Foreign Exchange Earnings: Income earned by a country from its exports, measured in foreign currency.
• Technology Transfer: The process of sharing or disseminating technology between different organizations or countries.

Key Economists

• Robert Solow: Developed the Solow Growth Model, emphasizing the role of technological progress in long-term economic growth.
• Paul Romer: Advanced the endogenous growth theory, highlighting the importance of knowledge, innovation, and human capital in driving growth.
• Adam Smith: Laid the foundations of classical economics, stressing the importance of free markets and trade in promoting economic growth.

Possible Essay-Style Questions

1. Discuss the relative importance of capital investment and technological advancements in driving long-term economic growth.
2. Compare and contrast actual growth and potential growth, providing real-world examples to illustrate your points.
3. Evaluate the role of international trade in the economic development of emerging economies, with a focus on export-led growth strategies.