Economic Growth Factors - Assignment Example

Topic:  Economic Assignment Economic thinkers, since times immemorial, have been interested in problems and implications of economic growth. In fact,economic growth was the central theme of classical economics. The classical economists like Adam Smith, David Ricardo, Malthus & others had greatly interested themselves in the problems of economic growth. Prof. Rostow (M.L. Seth 2003) defines economic growth as “a relation between rates on increase in capital and the working force on one hand, and increase in population on the other, such that per capita output is rising.” We may interpret “economic growth” to mean a sustained increase in per capita output (income) accompanied by reduction in existing inequalities and economic betterment of the masses. Basic Determinants of Economic Growth: 1. Capital Accumulation : As per Classical Economists, Capital accumulation is the core of economic development of a country. It is the main factor that helps economic growth of a country. Capital Accumulation (M.L. Seth 2003) is the outcome of savings. The profits earned by businessmen constitute the major source of savings of a community. Larger the profits, larger the savings of the community. The classical economists assumed that whatever was saved was invested. Larger the profits, larger the savings. Larger the savings, larger the investment. Larger the investment, higher the rate of growth of the economy. The rate of growth of the economy, thus, ultimately depended upon the level of profits. It is on account of this realization that classical economists looked upon profits as the pace-setters of economic growth. 2. Technology : The development of technology is another important determinant of Economic Growth. It accelerates the process of growth in the economy. Classical economists were aware of the role of technology as a stimulant of economic growth. Classical thinkers like Adam Smith and David Ricardo also realized the importance of technological improvement. According to Karl Marx, the adoption of improved technology causes the displacement of labor, increasing unemployment, decline in consumption, fall in effective demand, reduction in profits and ultimately slows down the process of economic growth. Despite the adverse effect of improved technology, capitalists, according to Marx, continue to opt for it because: a. Technological innovations raise profit, which in turn raise the rate of profit. b. Technological innovations bring temporary gains to the pioneering entrepreneur. c. Technological improvements raise the total volume of profits. 3. Capital-Output Ratio : George Rosen defined the Capital-Output Ratio as “the relationship of investment in a given economy or industry for a given time period to the output of the economy or industry for a similar time period.” The Capital-Output Ratio, thus, determines the rate at which the output grows as a result of a given volume of capital investment. For example: If capital investment of Rs. 5 is needed for an additional output of Rs. 1, the capital-output ratio would be 5:1. Hence, given the output, lower capital-output ratio would mean a need for smaller capital investment and vice-versa. It is difficult to estimate capital-output ratio because the productivity of capital depends upon many factors. A low Capital-Ratio is significant as capital accumulation for economic growth. This can be reduced by technological and organizational progress. However, Capital-output ratio cannot indicate the actual contribution of capital in a given investment because the calculation of capital-output ratio suffers from several difficulties. 4. Entrepreneurial ability : This is another important factor which stimulates the economic growth of a country. The classical economists, though they realized the role entrepreneurship in production, they did not assign it a key role in economic growth. Larger the number of goods, capable and efficient entrepreneurs, the faster the growth of the economy. An entrepreneur tries to widen the gaps between the value of final product and the remuneration paid to the factors of production. For this, an entrepreneur resorts to all different types of innovations. An innovating entrepreneur is, in reality, the successful entrepreneur. The larger the number of innovations, the higher the levels of profit; the higher the levels of profits, the faster the growth of the economy. 5. Expansion of demand : This is another factor which by stimulating production, helps the process of economic growth. The classical economists also recognized the importance of expansion of demand as a factor for economic growth. Adam Smith had clearly stated that division of labor, use of machinery and increase production were made possible by expansion of demand. Lord Keynes has specifically mentioned increase in aggregate demand as the essential prerequisite of growth. 6. Social and Institutional Factors : Favorable socio-cultural attitudes, a strong, stable, efficient and sympathetic administration, and equitable legal system, favorable socio-religious institutions, a high level of literacy and national character are some of the essential prerequisites of economic growth. These social and institutional factors have a significant impact on the economic growth of a country. The classical economists were aware of the role of social and institutional factors on economic growth. The socio-cultural attitudes and customs have actually hindered the process of economic growth in some under-developed countries. Religion and religious beliefs have a bearing on the people’s desire for economic growth. In ultimate analysis, the three fundamental factors inducing economic growth are labor, capital and technology. Any country which possesses these in ample measure is bound to attain a high level of growth. The western countries have made up for deficiency of labor by their highly developed technology and abundant supply of capital. In addition to the above factors there are a few more factors which determine economic growth. They are: a. Natural resources: the existence of abundant, rich natural resource is an essential requisite of economic growth. For example: there is no possibility of economic development in the great Sahara Desert because essential natural resources like water is not available out there whereas, USA has prospered because abundant natural resources in the form of water, land and mineral is available there. But this does not mean that a country short in natural resources, cannot achieve economic growth. b. The geographical position: the geographical location of a country is also important for economic growth. The prosperity of many countries is mainly due to their geographical location. Countries which can develop ties with developed countries are bound to develop faster. Secondly, climate plays an important role in the economic development of a country. A country which has extreme climate cannot develop fast. Ex. The Siberian region of the USSR. c. Growth of population: growth of population is another factor which determines economic growth. Increase in population, increases the demand for goods. Increase in demand for good facilitates the process of growth. Increase in demand also leads to greater employment opportunities. But in under-developed countries, increase in population leads to lower rates of savings which, in turn, brings down the economic growth. d. Favorable external circumstances: Favorable external circumstances include favorable terms of trade and inflow of foreign capital which, in turn, help the growth of an under-developed country. If the international prices of its exports go up, it means that the foreign exchange earnings of the country will go up. From this increased foreign exchange earnings, a country can buy its requirements of machinery from foreign countries. The effect is the same as that of unilateral money transfer from a developed country to an under-developed country. Economic growth has various benefits. Economic growth is essential as it improves the standard of living of people. But, in spite of all the benefits of economic development, it does not come cost free. Economic growth is a double-edged sword. There are several drawbacks of economic development like: 1. Inflation risks: There is the danger of demand-pull and cost-push inflation if demand grows faster than long run productive potential. High inflation can be destabilizing for an economy because it puts pressure on interest rates to rise and can cause a loss of competitiveness for domestic businesses in international markets 2. The environment: Economic growth has negative impact on environment. Fast growth of production and consumption increases noise and air pollution and road congestion. 3. Inequalities of income and wealth: All of the benefits of growth are not evenly distributed. We can see a rise in real GDP but also growing income and wealth inequality in society which is reflected in an increase in relative poverty. 4. Regional disparities: Although average living standards may be rising, the gap between rich and poor can widen leading to an increase in relative poverty and a widening of the gap between different regions. Example: China. China is one of the fastest developing country of the world. Economic growth took place at a high rate in china. But, this economic growth, came in with several drawbacks one of them being its impact on environment. Pollution problems have grown along with Chinas economy. China (BBC News, 2006) is the worlds largest sulphur dioxide polluter, emitting nearly 26m tons of the gas in 2005. This was a 27% increase since 2000 and coincided with a rise in coal consumption, the State Environmental Protection Administration (SEPA) said. The gas contributes to acid rain, which damages buildings, soil and crops, and can cause health problems in humans. Reference List: 1. Seth,M.L.,2003.Principles of Economics.36th ed.,Agra:Lakshmi Narain Agarwal. 2. Seth,M.L.,2003.Principles of Economics.36th ed.,Agra:Lakshmi Narain Agarwal. 3. BBC News,2006. China hit by rising air pollution[online](updated:Thursday, 3 August 2006) Available at: http://news.bbc.co.uk/2/hi/asia-pacific/5241844.stm [Accessed: 15th March 2010]. Read More