Studying Growth

Economic Growth Economic growth is extremely important because the bottom line for an economy is its ability to satisfy human wants. You might argue whether the most “successful” economy is the one that provides its citizens with the highest levels of welfare or the one that improves (increases) their welfare at the most rapid rate, but undeniably the success of an economy is in some way directly related to human welfare. Adam Smith had pointed this out as far back as 1776 in his book Wealth of Nations. He insisted that the wealth of a nation is determined not by the amount of gold in the national treasury, but by how many goods and services could be acquired by its entire population.

In other words, the “wealth of nation” is the standard of living enjoyed by the individuals residing in the country. The best performing economy is the one that provides the greatest amount of welfare for the greatest number of people. Economic growth is meaningful only as a concept that describes the well-being of individuals. Some people still associate a nation’s military might or its visibility in international politics with “wealth”. The fallacy of such a view is easily illustrated by few obvious cases: Despite their military strength and prominence in the news, countries such as Serbia, North Korea and Iran are doing a dismal job of satisfying their citizens’ basic wants and desires.

A similarly misguided concept of national wealth is the availability of natural resources. If the presence of oil or fertile soil were important determinants of economic growth and human welfare, then poor countries such as Iran, Nigeria, Ukraine, or Kazakhstan should be the envy of the world. In terms of per capita income, these and many other resource-rich countries are not occupying top positions. On the other hand, the citizens of Japan, a country without any exceptional endowments of natural resources other than its proximity to the sea, enjoy one of the highest levels of per capita income. And Taiwan, another island economy with relatively few natural resources, has enjoyed the fastest rate of economic growth.

Resources mean nothing until they are used to produce goods and services that let people live longer, more comfortably, and with more options and opportunities. It is often considered that the most important resources are the ideas generated by the human mind, not the minerals found in the ground. The only meaningful way to study economic growth is to focus on how and why individual welfare changes over time.

Not only should we disregard military power, international prestige, and proven reserves of oil, but we should avoid all measures that do not accurately reflect the welfare of people. We therefore define economic growth as growth in human welfare.

Growth or Development The fact is that there is little agreement on exactly what is meant by economic development or economic growth. Virtually, all economists would agree that an increase in welfare-enhancing output is part of the growth process. That is, economic growth involves increasing the capacity of the economy to satisfy the wants and needs of its inhabitants. But, how is development different from growth?

It is often suggested that growth merely refers to the growth of output, while development refers to all the changes in the economy including the social, political, and institutional changes that accompany changes in output. According to Simon Kuznets: “Growth is a sustained increase in per capita income or per worker product” According to Douglass North and Robert Paul Thomas: “Economic growth occurs if output grows faster than population”. (Of course, we must view “output” as including all goods and services enjoyed by people whether or not they are normally recorded in formal measures of national product).

Structural Change and Economic Growth What is structural change? It is a process that alters almost all aspects of prodcution and consumption. Rich economies produce a very different mix of goods and services, and they generally use very different production methods. The people living in the “rich” economies generally work at different jobs and consume different baskets of goods and services in comparison to people living in economies that generate only low per capita levels of output.

Percentage Contributions to GDP AgricultureIndustryServicesAll A. 16 OECD Countries B. Data for Low-, Middle-, and High- Income Economies Low-Income Economies Middle-Income Economies High-Income Economies

The structural change that a growing economy goes through is easily seen in the above Table. Part A of the table presents data that indicate how the components of national output have changed over the past century for the group of economies that grew fastest over the past 200 years and today enjoy the highest levels of per capita output. The table shows how output is divided among the three major sectors of the economy: agriculture, industry, and services. Note that the economies with the highest per capita levels of output have the smallest agricultural sectors, as a percentage of the value of total output, and the largest service sectors.

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