Economic growth

Economists see the economy as a system which generates a flow of goods and services produced by businesses, for the use of households and consumers. A counter flow of payments takes place to the factor inputs used in the production of these goods and services (land, labour, capital).

This so called “circular flow” is a basic model of the relationship between flows of physical goods and money flows. The model may be refined to show the existence of a range of injections into, and leakages from, this simple circular flow model.

Some of the household incomes generated in producing goods and services in the domestic economy “leak out” of the system. That is to say, the money is not passed into domestic business. For example, spending on imports goes to foreign firms and individuals. Taxes go to the government and savings are held by financial institutions. Imports, taxes are “ leakages” which are not directly received by domestic businesses. On the other hand, domestic businesses receive income from sources other than domestic households. They are called “injections”. For example, domestic businesses receive income from overseas households and businesses when they export. Some domestic businesses also receive income from the government or by way of investment when other businesses buy plant or equipment. Exports, government spending and investment are classed as “injections” which domestic business receive from the sources other than domestic households.

Any surplus of injections over leakages will increase the flow of income (create domestic growth) while a surplus of leakages over injections will reduce the flow of income (cause negative economic growth). Since this flow of income passes through businesses, their activities will inevitably be affected and they will have to plan their activities with possible future changes in mind, if they are to survive and prosper.

Governments seek by various means to maximize the flow of income in the system. It can be seen that government management of the economy in this way is channelled through business, hence the need for business to be aware of the threats and opportunities offered by changes in government economic policy.

Economic growth is the most important of the economic indicators mentioned above. It is a measure of the rate at which the real output of the economy is growing over time. By “real output” we mean actual volume of goods and services produced by the economy (and the income which flow from this output).

The Gross Domestic Product (GDP) is the concept often used to measure output. This refers to the output produced by individuals and businesses actually located within the boundaries of the domestic economy.

FACTORS LEADING TO GROWTH

• The discovery of a hitherto unexploited natural resource, such as oil may generate a surge in growth. The value of the new output of oil and gas would increase GDP in its own right. However there would be enormous spin-offs in activity in all the necessary support industries, engineering, transport, etc.

• The government of human skills will increase the capacity of an economy to grow. Thus economies where a high proportion of school leavers proceed to higher education will tend to have higher growth rates than those where a lower proportion do so.

• Capital accumulation is also critical to the generation of growth. This is often called investment and refers to the process of adding to the net stock of physical capital, machines, buildings and plants in the private business sector; it also includes additions or improvements to the infrastructure by public authorities.

• Rapid developments in technology, which bring about the possibility of productivity gains (more output from the same resources), may also induce a surge in growth.

A cycle of growth can be “cumulative”. For example, the higher incomes which accompany economic growth may permit higher savings, which in turn may be channeled into the higher investment which promotes further growth.