Macroeconomic Indicator – Growth Rate – By Dr. Gnana Sankaralingam
Growth rate is an important indicator of economic objective of improved living standards, increased tax revenues and job creation. It refers to the percentage change of an economy within a specified period. Growth rate of an economy is derived as the annual rate of change at which the gross domestic product (GDP) of the country increases or decreases. It can be positive or negative depending whether the economy is growing or declining. They are not usually constant over the course of the years experiencing booms, recession, slumps and depression. GDP is the most popular way to measure growth rate, calculated by adding up consumer spending, business investments, government spending and total foreign trade (exports minus imports). Rate of growth of real GDP (value of goods and services produced in the economy adjusted to remove effects of inflation) gives the actual figure.
Growth rate is looked at three different methods: Quarterly rate compounded to annual rate which looks at the change in GDP from a quarter to quarter and multiplies it by four; Four quarters or year by year growth rate which compares GDP of a single quarter from two successive years as a percentage; Annual average growth rate which looks at the changes in each quarter and the sum of these is divided by four. Three ways in measuring of growth are GDP the most widely used, Gross National Index (GNI) and net domestic product (NDP) which adjusts GDP for depreciation of capital assets of a country. Growth rate is used to assess growth periodically and make predictions about future performance.
Growth rate can be affected by several factors: Higher wages and tax cuts will increase consumer spending; lower interest rates could increase investments and consumer spending; Increase in government spending will raise the GDP; Devaluation of currency will increase exports and reduce imports. Major determinants of growth are natural resources, human resources of both skilled and unskilled workers, capital goods such as machinery and infrastructure, improved technology which allows faster production, increased demand for goods and services in the economy, efficiency both productive and allocative whereby using the available resources to the maximum extent as possible in the least expensive manner to produce optimum mix of goods and services. Country needs to expand its resources through time which will result in the increase in the productive capacity of its economy.
Growth goes through different phases relating to periods of economic activity referred to as business cycles consisting of: Expansion during which employment, industrial production, income and sales increase; Peak which occurs when expansion reaches the top which is effectively a turning point; Contraction during which elements of expansion begin to decrease, and if a significant decline in economic activity spreads across the economy, it becomes a recession; Trough which occurs when contraction descends to the bottom. Single business cycle is from a peak to peak or a trough to trough. Cycles are not generally regular in length and there could be a period of contraction during expansion or vice versa. Cycles are recurrent but not periodic. Boom is when the economy is growing quickly and slump is a long period of recession. Sustained recession over several years is depression.
Economic growth which is an increase in productive potential of a country is of different types. In the short run type, it is measured by percentage change in real national output which is the actual growth derived after removing the effect of inflation from growth rate figure. Increase in actual growth are usually due to increase in aggregate demand which is the total spending on goods and services (government spending, consumer spending and investment etc), but they could be caused by increase in aggregate supply which is the total output in an economy. In the long run type, growth is shown by an increase in the trend rate which is the average rate of economic growth over period of both booms and slumps. Long run or potential growth is caused by increase in the productivity which happens due to rise in quality or quantity of inputs such as advanced machinery of skilled labour. As the trend rate rises smoothly unlike the fluctuating actual growth rate, they do not match.
Output gap is the difference between the actual output and the trend output (average output over a period of time). It can be positive when actual output is above trend output or negative when actual output is below trend output. Positive ouput gap also called inflationary gap, occurs during a boom when the economy is over heating as resources are being fully used or overused causing a fall in unemployment, which means upward pressure on inflation. Negative output gap also called recessionary gap, occurs during a slump when the economy is under performing as resources are unused or underutilised causing a rise in unemployment, which means downward pressure on inflation. During the recovery phase, economy will go from having negative output gap to having positive output gap.
Growth rate when increases, could come into conflict with other economic objectives. Economic growth can put a strain on the environment such as air pollution from factories and waste that needs to be disposed of. It could increase inequality, as high skilled workers may be more in demand than others whose tasks can be substituted by machinery. Governments can try to decrease inequality by using increased tax revenue form increased growth, to increase welfare payments and raise minimum wage. Growth rate has an impact on inflation as a rapidly growing economy can cause large increase in prices due to increase in demand, which can result in higher than desirable inflation. If interest rates are kept high to reduce inflation, it would encourage saving thereby reducing investments and consumer spending which may retard growth. Growth rate can have an effect on balance of payments as the rising in real income levels would lead to increased imports resulting in deficit on the current account, which needs to be met by releasing foreign exchange reserves.
Sustainable growth rate which means making sure that the economy keeps growing every year without causing problems and gain long term benefit to the society. It relies on the ability of the country to expand output every year, find continuous supply of raw materials, land, labour etc to keep on the production and find markets for the outputs so that the items are always being bought. As it is not possible to do all these things at the same time, it makes it difficult for a country to achieve sustainable growth. In the short run governments decide which objectives are more important and make trade offs.
