Economic growth is the increase in the goods and services produced by an economy, typically a nation, over a long period of time. It is measured as percentage increase in real gross domestic product (GDP) which is gross domestic product (GDP) adjusted for inflation. GDP is the market value of all final goods and services produced in an economy or nation. So how does a nation or economy continually increase the GDP such that the economic growth trends upward? There are three main types of economic growth theories over time that have all attempted to answer that exact question. The Classical, Neo-Classical, and Modern Day theories will each be described. The classical theory of economic growth was a combination of economic work done by Adam Smith, David Ricardo, and Robert Malthus in the eighteenth and nineteenth centuries. The theory states that every economy has a steady state GDP and any deviation off of that steady state is temporary and will eventually return. This is based on the concept that when there is a growth in GDP, population will increase.
The increase in population thus has an adverse effect on GDP due to the higher demand on limited resources from a larger population. The GDP will eventually lower back to the steady state. When GDP deviates below the steady state, population will decrease and thus lower demand on the resources. In turn, the GDP will rise back to its steady state. Next, we have Neo-Classical theory. Two economists, T.W. Swan and Robert Solow, made important contributions to economic growth theory in developing what is now known as the Solow-Swan growth model. The theory focuses on three factors that impact economic growth: labor, capital, and technology, or more specifically, technological advances. The output per worker (growth per unit of labor) increases with the output per capita (growth per unit of capital) but at a decreasing rate. This is referred to as diminishing marginal returns. Therefore, there will become a point at which labor and capital can be set to reach an equilibrium state. Since a nation can theoretically determine the amount of labor and capital necessary to remain at that steady point, it is technological advances that really impact the economic growth. The theory states that economic growth will not take place unless there are technological advances, and those advances happen by chance. Once an advance has been made, then labor and capital should be adjusted accordingly. It also suggests that if all nations have access to the same technology, then the standard of living will all become equal. There were two major concerns with this era of theories. One is the conclusion that continuous economic growth can only occur with technological advances, which happen by chance and therefore cannot be modeled. Secondly, it relies on diminishing marginal returns of capital and labor. However, there is no empirical or real-life evidence to support this claim. Therefore the model is known for identifying technology as a factor in growth but fails to ever substantially explain how.
The rate of growth of population is faster than the rate of economic development. The state revenue received through taxes, fees, etc., is not sufficient to provide full employment to the labor force. The per capita income is extremely low and so is the capacity to save. Foreign loans for development purposes are not without strings and are also not available in desired quantity. There is a dearth of stock of capital in the country. People lack initiative and entrepreneurial ability. People are mostly extravagant and there is less voluntary savings. A greater portion of the population lives in villages and are contended with their lot. The government cannot incur the displeasure of the people by enhancing the tax rates beyond a certain limit. It cannot also impose additional taxes for the same reason. Thus there is too much evasion of taxes. Under the conditions stated above, the reader can easily visualize the state of affairs with which a government of the backward country is confronted. Still no government would like to be a silent spectator and would desire that the standard of living of the people should go up in the shortest possible period of time. It will try to find money from the blue if necessary for spreading economic development of the country. Here deficit financing comes to its rescue. The state uses this instrument for lifting the economy out of depression and for accelerating economic development in the country. If, however, the state can increase the volume of resources by increasing the tax rates, imposing additional taxes or mobilizing enlarged saving, then it is not desirous to adopt deficit financing as it is a very delicate instrument.
Economic development is a normative concept i.e. it applies in the context of people’s sense of morality (right and wrong, good and bad). The definition of economic development given by Michael Todaro is an increase in living standards, improvement in self-esteem needs and freedom from oppression as well as a greater choice. The most accurate method of measuring development is the Human Development Index which takes into account the literacy rates & life expectancy which affect productivity and could lead to Economic Growth. Economic Growth does not take into account the size of the informal economy. The informal economy is also known as the black economy which is unrecorded economic activity. Development alleviates people from low standards of living into proper employment with suitable shelter. Economic Growth does not take into account the depletion of natural resources which might lead to pollution, congestion & disease. Development however is concerned with sustainability which means meeting the needs of the present without compromising future needs. These environmental effects are becoming more of a problem for Governments now that the pressure has increased on them due to Global warming.