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Economic growth can be defined as the increase or improvement in the inflation-adjusted
market value Market value or OMV (Open Market Valuation) is the price at which an asset would trade in a Market (economics), competitive auction setting. Market value is often used interchangeably with ''open market value'', ''fair value'' or ''fair market va ...
of the goods and services produced by an
economy An economy (; ) is an area of the production Production may be: Economics and business * Production (economics) * Production, the act of manufacturing goods * Production, in the outline of industrial organization, the act of making products ...

economy
over time. Statisticians conventionally measure such growth as the percent rate of increase in the real
gross domestic product Gross domestic product (GDP) is a monetary Image:National-Debt-Gillray.jpeg, In a 1786 James Gillray caricature, the plentiful money bags handed to King George III are contrasted with the beggar whose legs and arms were amputated, in the ...
, or real GDP. Growth is usually calculated in ''real'' terms – i.e., inflation-adjusted terms – to eliminate the distorting effect of
inflation In economics, inflation refers to a general progressive increase in prices of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a r ...

inflation
on the prices of
goods In economics Economics () is a social science Social science is the branch A branch ( or , ) or tree branch (sometimes referred to in botany Botany, also called , plant biology or phytology, is the science of plant ...

goods
produced. Measurement of economic growth uses
national income accounting A variety of measures of national income and output are used in economics to estimate total economic activity in a country or region, including gross domestic product (GDP), gross national product (GNP), net national income (NNI), and adjusted natio ...
. Since economic growth is measured as the annual percent change of gross domestic product (GDP), it has all the advantages and drawbacks of that measure. The economic growth-rates of countries are commonly compared using the ratio of the
GDP Gross domestic product (GDP) is a monetary In a 1786 James Gillray caricature, the plentiful money bags handed to King George III are contrasted with the beggar whose legs and arms were amputated, in the left corner">174x174px Money is any ...
to population (
per-capita income The median income is the income Income is the consumption and saving opportunity gained by an entity within a specified timeframe, which is generally expressed in monetary terms.Smith's financial dictionary. Smith, Howard Irving. 1908. Income is de ...
). The "rate of economic growth" refers to the
geometric Geometry (from the grc, γεωμετρία; '' geo-'' "earth", '' -metron'' "measurement") is, with arithmetic, one of the oldest branches of mathematics. It is concerned with properties of space that are related with distance, shape, size, ...

geometric
annual rate of growth in GDP between the first and the last year over a period of time. This growth rate represents the trend in the average level of GDP over the period, and ignores any fluctuations in the GDP around this trend. Economists refer to an increase in economic growth caused by more efficient use of inputs (increased
productivity Productivity is the efficiency Efficiency is the (often measurable) ability to avoid wasting materials, energy, efforts, money, and time in doing something or in producing a desired result. In a more general sense, it is the ability to do thin ...
of
labor Labour or labor may refer to: * , the delivery of a baby * , or work ** , physical work ** , a socioeconomic relationship between a worker and an employer Literature * , an American quarterly on the history of the labor movement * ', an academic ...
, of
physical capital Physical capital represents in economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), production, distribution (economics), distribution, and Consumption (economi ...
, of
energy In physics Physics is the that studies , its , its and behavior through , and the related entities of and . "Physical science is that department of knowledge which relates to the order of nature, or, in other words, to the regula ...
or of
material Material is a substance Substance may refer to: * Substance (Jainism), a term in Jain ontology to denote the base or owner of attributes * Chemical substance, a material with a definite chemical composition * Matter, anything that has mass and ...

material
s) as ''
intensive growth In the economic An economy (; ) is an area of the production Production may be: Economics and business * Production (economics) * Production, the act of manufacturing goods * Production, in the outline of industrial organization, the act o ...
''. In contrast, GDP growth caused only by increases in the amount of inputs available for use (increased population, for example, or new territory) counts as ''
extensive growthExtensive growth, in economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consum ...
''.
Development of new goods and services
Development of new goods and services
also generates economic growth. As it so happens, in the U.S. about 60% of
consumer spending Consumer spending is the total money spent on final goods and services by individuals and households. There are two components of consumer spending: induced consumption Induced consumption is the portion of consumption that varies with disposabl ...
in 2013 went on goods and services that did not exist in 1869.


Measurement

The economic growth rate is calculated from data on GDP estimated by countries' statistical agencies. The rate of growth of GDP
per capita ''Per capita'' is a Latin phrase literally meaning "by heads" or "for each head", and idiomatically used to mean "per person". The term is used in a wide variety of social sciences and statistical research contexts, including government statistic ...
is calculated from data on GDP and people for the initial and final periods included in the analysis of the analyst.


Long-term growth

Living standards vary widely from country to country, and furthermore, the change in living standards over time varies widely from country to country. Below is a table which shows GDP per person and annualized per person GDP growth for a selection of countries over a period of about 100 years. The GDP per person data are adjusted for inflation, hence they are "
real Real may refer to: * Reality Reality is the sum or aggregate of all that is real or existent within a system, as opposed to that which is only Object of the mind, imaginary. The term is also used to refer to the ontological status of things, ind ...
". GDP per person (more commonly called "per capita" GDP) is the GDP of the entire country divided by the number of people in the country; GDP per person is conceptually analogous to "
average income Per capita income (PCI) or total income measures the average income earned per person in a given area (city, region, country, etc.) in a specified year. It is calculated by dividing the area's total income by its total population. Per capita in ...
". Seemingly small differences in yearly GDP growth lead to large changes in GDP when
compounded
compounded
over time. For instance, in the above table, GDP per person in the United Kingdom in the year 1870 was $4,808. At the same time in the United States, GDP per person was $4,007, lower than the UK by about 20%. However, in 2008 the positions were reversed: GDP per person was $36,130 in the
United Kingdom The United Kingdom of Great Britain and Northern Ireland, commonly known as the United Kingdom (UK) or Britain,Usage is mixed. The Guardian' and Telegraph' use Britain as a synonym for the United Kingdom. Some prefer to use Britain as shorth ...

United Kingdom
and $46,970 in the United States, i.e. GDP per person in the US was 30% more than it was in the UK. As the above table shows, this means that GDP per person grew, on average, by 1.80% per year in the US and by 1.47% in the UK. Thus, a difference in GDP growth by only a few tenths of a percent per year results in large differences in outcomes when the growth is persistent over a generation. This and other observations have led some economists to view GDP growth as the most important part of the field of
macroeconomics Macroeconomics (from the Greek prefix ''makro-'' meaning "large" + ''economics'') is a branch of economics Economics () is a social science Social science is the branch A branch ( or , ) or tree branch (sometimes referred ...
:


Growth and innovation

It has been observed that GDP growth is influenced by the size of the economy. The relation between GDP growth and GDP across the countries at a particular point of time is convex. Growth increases with GDP reaches its maximum and then begins to decline. There exists some extremum value. This is not exactly middle-income trap. It is observed for both developed and developing economies. Actually, countries having this property belong to ''conventional growth domain''. However, the extremum could be extended by technological and policy innovations and some countries move into ''innovative growth domain'' with higher limiting values.


Determinants of per capita GDP growth

In national income accounting, per capita output can be calculated using the following factors: output per unit of labor input (labor productivity), hours worked (intensity), the percentage of the working-age population actually working (participation rate) and the proportion of the working-age population to the total population (demographics). "The rate of change of GDP/population is the sum of the rates of change of these four variables plus their cross products." Economists distinguish between long-run economic growth and short-run economic changes in
production Production may be: Economics and business * Production (economics) * Production, the act of manufacturing goods * Production, in the outline of industrial organization, the act of making products (goods and services) * Production as a statistic, g ...
. Short-run variation in economic growth is termed the ''
business cycle The business cycle, also known as the economic cycle or trade cycle, are the fluctuations of gross domestic product Gross domestic product (GDP) is a monetary Image:National-Debt-Gillray.jpeg, In a 1786 James Gillray caricature, the pl ...

business cycle
''. Generally, economists attribute the ups and downs in the business cycle to fluctuations in
aggregate demand In macroeconomics Macroeconomics (from the Greek prefix ''makro-'' meaning "large" + ''economics'') is a branch of economics Economics () is a social science Social science is the branch A branch ( or , ) or tree branc ...
. In contrast, economic growth is concerned with the long-run trend in production due to structural causes such as technological growth and factor accumulation.


Productivity

Increases in labor
productivity Productivity is the efficiency Efficiency is the (often measurable) ability to avoid wasting materials, energy, efforts, money, and time in doing something or in producing a desired result. In a more general sense, it is the ability to do thin ...
(the ratio of the value of output to labor input) have historically been the most important source of real per capita economic growth. "In a famous estimate, MIT Professor
Robert Solow Robert Merton Solow, Order of Prince Henry, GCIH (; born August 23, 1924) is an American economist whose work on the theory of economic growth culminated in the exogenous growth model named after him. He is currently Emeritus List of Institute Prof ...
concluded that technological progress has accounted for 80 percent of the long-term rise in U.S. per capita income, with increased investment in capital explaining only the remaining 20 percent." Increases in productivity lower the real cost of goods. Over the 20th century the real price of many goods fell by over 90%. Economic growth has traditionally been attributed to the accumulation of human and physical capital and the increase in productivity and creation of new goods arising from technological innovation. Further
division of labour The division of labour is the separation of tasks in any economic system An economic system, or economic order, is a system A system is a group of interacting Interaction is a kind of action that occurs as two or more objects have an ...
(specialization) is also fundamental to rising productivity. Before
industrialization Industrialisation ( alternatively spelled industrialization) is the period of social and economic change that transforms a human group from an agrarian society An agrarian society, or agricultural society, is any community whose economy is b ...
technological progress resulted in an increase in the population, which was kept in check by food supply and other resources, which acted to limit per capita income, a condition known as the
Malthusian trap Malthusianism is the idea that population growth is potentially exponential while the growth of the food supply Food security is a measure of the availability of food and individuals' Economic inequality, ability to access it. According the Comm ...
. The rapid economic growth that occurred during the
Industrial Revolution The Industrial Revolution was the transition to new manufacturing processes in Great Britain, continental Europe Continental Europe or mainland Europe is the contiguous continent A continent is any of several large landmasse ...
was remarkable because it was in excess of population growth, providing an escape from the Malthusian trap. Countries that industrialized eventually saw their population growth slow down, a phenomenon known as the
demographic transition In demography Demography (from prefix ''demo-'' from Ancient Greek δῆμος (''dēmos'') meaning 'the people', and ''-graphy'' from γράφω (''graphō'') meaning 'writing, description or measurement') is the statistics, statistical s ...
. Increases in productivity are the major factor responsible for per capita economic growth—this has been especially evident since the mid-19th century. Most of the economic growth in the 20th century was due to increased output per unit of labor, materials, energy, and land (less input per widget). The balance of the growth in output has come from using more inputs. Both of these changes increase output. The increased output included more of the same goods produced previously and new goods and services.Kendrick, J. W. 1961
Productivity trends in the United States
" Princeton University Press
During the
Industrial Revolution The Industrial Revolution was the transition to new manufacturing processes in Great Britain, continental Europe Continental Europe or mainland Europe is the contiguous continent A continent is any of several large landmasse ...
,
mechanization Mechanization is the process of changing from working largely or exclusively by hand or with animals to doing that work with machinery. In an early engineering text a machine is defined as follows: In some fields, mechanization includes the ...
began to replace hand methods in manufacturing, and new processes streamlined production of chemicals, iron, steel, and other products.
Machine tool A machine tool is a machine for handling or machining metal or other rigid materials, usually by cutting, Boring (manufacturing), boring, grinding (abrasive cutting), grinding, shearing, or other forms of deformations. Machine tools employ some s ...
s made the economical production of metal parts possible, so that parts could be interchangeable. (See:
Interchangeable parts Interchangeable parts are parts (components Component may refer to: In engineering, science, and technology Generic systems *System A system is a group of Interaction, interacting or interrelated elements that act according to a set of rules to ...

Interchangeable parts
.) During the
Second Industrial Revolution The Second Industrial Revolution, also known as the Technological Revolution, was a phase of rapid standardization Standardization or standardisation is the process of implementing and developing technical standards based on the consensus ...
, a major factor of
productivity Productivity is the efficiency Efficiency is the (often measurable) ability to avoid wasting materials, energy, efforts, money, and time in doing something or in producing a desired result. In a more general sense, it is the ability to do thin ...
growth was the substitution of inanimate power for human and animal labor. Also there was a great increase in power as steam-powered
electricity generation Electricity generation is the process of generating electric power Electric power is the rate, per unit time, at which electrical energy Electrical energy is energy derived as a result of movement of electrically charged particles. When use ...
and internal combustion supplanted limited wind and
water power Hydropower (from el, ὕδωρ, "water"), also known as water power, is the use of falling or fast-running water Water (chemical formula H2O) is an , transparent, tasteless, odorless, and , which is the main constituent of 's and th ...
. Since that replacement, the great expansion of total power was driven by continuous improvements in energy conversion efficiency. Other major historical sources of productivity were
automation Automation describes a wide range of technologies that reduce human intervention in processes. Human intervention is reduced by predetermining decision criteria, subprocess relationships, and related actions — and embodying those predeterm ...
, transportation infrastructures (canals, railroads, and highways), new materials (steel) and power, which includes steam and internal combustion engines and
electricity Electricity is the set of physical Physical may refer to: *Physical examination, a regular overall check-up with a doctor *Physical (album), ''Physical'' (album), a 1981 album by Olivia Newton-John **Physical (Olivia Newton-John song), "Physi ...

electricity
. Other
productivity Productivity is the efficiency Efficiency is the (often measurable) ability to avoid wasting materials, energy, efforts, money, and time in doing something or in producing a desired result. In a more general sense, it is the ability to do thin ...
improvements included
mechanized agriculture Mechanised agriculture is the process of using agricultural machinery Agricultural machinery relates to the machine (mechanical), mechanical structures and devices used in farming or other agriculture. There are list of agricultural machinery ...
and scientific agriculture including chemical
fertilizer A fertilizer (American English American English (AmE, AE, AmEng, USEng, en-US), sometimes called United States English or U.S. English, is the set of varieties of the English language native to the United States. Currently, American E ...

fertilizer
s and livestock and poultry management, and the
Green Revolution The Green Revolution, or the Third Agricultural Revolution (after the Neolithic Revolution The Neolithic Revolution, or the (First) Agricultural Revolution, was the wide-scale transition of many human culture Culture () is an umbrel ...

Green Revolution
.
Interchangeable parts Interchangeable parts are parts (components Component may refer to: In engineering, science, and technology Generic systems *System A system is a group of Interaction, interacting or interrelated elements that act according to a set of rules to ...

Interchangeable parts
made with
machine tool A machine tool is a machine for handling or machining metal or other rigid materials, usually by cutting, Boring (manufacturing), boring, grinding (abrasive cutting), grinding, shearing, or other forms of deformations. Machine tools employ some s ...
s powered by s evolved into
mass production Mass production, also known as flow production or continuous production, is the production of substantial amounts of standardized Standardization or standardisation is the process of implementing and developing technical standard A techni ...
, which is universally used today. Great sources of productivity improvement in the late 19th century were railroads, steam ships, horse-pulled
reaper A reaper is a agricultural machinery, farm implement or person that wikt:reap#Verb, reaps (cuts and often also gathers) crops at harvest when they are ripe. Usually the crop involved is a cereal grass. The first documented reaping machines were ...

reaper
s and
combine harvester The modern combine harvester, or simply combine, is a versatile machine designed to efficiently harvest a variety of grain crops. The name derives from its combining four separate harvesting operations—reaping, threshing An animal-powered thre ...

combine harvester
s, and
steam Steam is water Water (chemical formula H2O) is an Inorganic compound, inorganic, transparent, tasteless, odorless, and Color of water, nearly colorless chemical substance, which is the main constituent of Earth's hydrosphere and the fl ...

steam
-powered factories. The invention of processes for making cheap
steel Steel is an alloy An alloy is an admixture of metal A metal (from Ancient Greek, Greek μέταλλον ''métallon'', "mine, quarry, metal") is a material that, when freshly prepared, polished, or fractured, shows a lustrous appe ...

steel
were important for many forms of
mechanization Mechanization is the process of changing from working largely or exclusively by hand or with animals to doing that work with machinery. In an early engineering text a machine is defined as follows: In some fields, mechanization includes the ...
and transportation. By the late 19th century both prices and weekly work hours fell because less labor, materials, and energy were required to produce and transport goods. However, real wages rose, allowing workers to improve their diet, buy consumer goods and afford better housing.
Mass production Mass production, also known as flow production or continuous production, is the production of substantial amounts of standardized Standardization or standardisation is the process of implementing and developing technical standard A techni ...
of the 1920s created
overproduction In economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods ...
, which was arguably one of several
causes of the Great Depression The causes of the Great Depression in the early 20th century in the USA have been extensively discussed by economists and remain a matter of active debate. They are part of the larger debate about economic crises and recession In economics, a r ...
of the 1930s. Following the
Great Depression The Great Depression was a severe worldwide economic depression An economic depression is a sustained, long-term downturn in economic activity in one or more economies. It is a more severe economic downturn than a economic recession, recess ...
, economic growth resumed, aided in part by increased demand for existing goods and services, such as automobiles, telephones, radios, electricity and household appliances. New goods and services included television, air conditioning and commercial aviation (after 1950), creating enough new demand to stabilize the work week. The building of highway infrastructures also contributed to post World War II growth, as did capital investments in manufacturing and chemical industries. The post World War II economy also benefited from the discovery of vast amounts of oil around the world, particularly in the
Middle East The Middle East ( ar, الشرق الأوسط, ISO 233 The international standard An international standard is a technical standard A technical standard is an established norm (social), norm or requirement for a repeatable technical task whi ...

Middle East
. By John W. Kendrick's estimate, three-quarters of increase in U.S. per capita GDP from 1889 to 1957 was due to increased productivity. Economic growth in the
United States The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country Continental United States, primarily located in North America. It consists of 50 U.S. state, states, a Washington, D.C., ...

United States
slowed down after 1973. In contrast growth in
Asia Asia () is Earth's largest and most populous continent, located primarily in the Eastern Hemisphere, Eastern and Northern Hemisphere, Northern Hemisphere of the Earth, Hemispheres. It shares the continental landmass of Eurasia with the cont ...

Asia
has been strong since then, starting with
Japan Japan ( ja, 日本, or , and formally ) is an island country An island country or an island nation is a country A country is a distinct territory, territorial body or political entity. It is often referred to as the land of an in ...

Japan
and spreading to
Four Asian Tigers The Four Asian Tigers (also known as the Four Asian Dragons or Four Little Dragons in Chinese Chinese can refer to: * Something related to China China, officially the People's Republic of China (PRC), is a country in East Asia. It is the ...

Four Asian Tigers
,
China China (), officially the People's Republic of China (PRC; ), is a country in East Asia East Asia is the eastern region of Asia Asia () is Earth's largest and most populous continent, located primarily in the Eastern Hemisphere ...

China
,
Southeast Asia Southeast Asia, also spelled South East Asia and South-East Asia, and also known as Southeastern Asia or SEA, is the geographical United Nations geoscheme for Asia#South-eastern Asia, southeastern subregion of Asia, consisting of the regions ...

Southeast Asia
, the Indian subcontinent and
Asia Pacific The Asia-Pacific is the part of the world In its most general sense, the term "world" refers to the totality of entities, to the whole of reality or to everything that is. The nature of the world has been conceptualized differently in dif ...
. In 1957
South Korea South Korea, officially the Republic of Korea (ROK), is a country in East Asia, constituting the southern part of the Korea, Korean Peninsula and sharing a Korean Demilitarized Zone, land border with North Korea. Its western border is for ...

South Korea
had a lower per capita
GDP Gross domestic product (GDP) is a monetary Image:National-Debt-Gillray.jpeg, In a 1786 James Gillray caricature, the plentiful money bags handed to King George III are contrasted with the beggar whose legs and arms were amputated, in the ...
than
Ghana Ghana (), officially the Republic of Ghana, is a country in West Africa West Africa or Western Africa is the westernmost region of . The defines Western Africa as the 17 countries of , , , , , , , , , , , , , , , and as well as .Paul R. ...

Ghana
, and by 2008 it was 17 times as high as Ghana's. The Japanese economic growth has slackened considerably since the late 1980s. Productivity in the United States grew at an increasing rate throughout the 19th century and was most rapid in the early to middle decades of the 20th century. U.S. productivity growth spiked towards the end of the century in 1996–2004, due to an acceleration in the rate of technological innovation known as
Moore's law Moore's law is the observation that the number of transistor upright=1.4, gate Candi bentar, a typical Indonesian gate that is often found on the islands of Java">Indonesia.html" ;"title="Candi bentar, a typical Indonesia">Candi be ...
. After 2004 U.S. productivity growth returned to the low levels of 1972–96.


Factor accumulation

Capital in economics ordinarily refers to physical capital, which consists of structures (largest component of physical capital) and equipment used in business (machinery, factory equipment, computers and office equipment, construction equipment, business vehicles, medical equipment, etc.). Up to a point increases in the amount of capital per worker are an important cause of economic output growth. Capital is subject to
diminishing returns In economics Economics () is a social science Social science is the Branches of science, branch of science devoted to the study of society, societies and the Social relation, relationships among individuals within those societies. ...

diminishing returns
because of the amount that can be effectively invested and because of the growing burden of depreciation. In the development of economic theory, the distribution of income was considered to be between labor and the owners of land and capital. In recent decades there have been several Asian countries with high rates of economic growth driven by capital investment. The work week declined considerably over the 19th century. By the 1920s the average work week in the U.S. was 49 hours, but the work week was reduced to 40 hours (after which overtime premium was applied) as part of the
National Industrial Recovery Act The National Industrial Recovery Act of 1933 (NIRA) was a US labor law and consumer law Consumer protection is the practice of safeguarding buyers of goods and services, and the public, against unfair practices in the marketplace. Consumer pro ...
of 1933. Demographic factors may influence growth by changing the employment to population ratio and the labor force participation rate.
Industrialization Industrialisation ( alternatively spelled industrialization) is the period of social and economic change that transforms a human group from an agrarian society An agrarian society, or agricultural society, is any community whose economy is b ...
creates a
demographic transition In demography Demography (from prefix ''demo-'' from Ancient Greek δῆμος (''dēmos'') meaning 'the people', and ''-graphy'' from γράφω (''graphō'') meaning 'writing, description or measurement') is the statistics, statistical s ...
in which birth rates decline and the average age of the population increases. Women with fewer children and better access to market employment tend to join the labor force in higher percentages. There is a reduced demand for child labor and children spend more years in school. The increase in the percentage of women in the labor force in the U.S. contributed to economic growth, as did the entrance of the
baby boomer Baby boomers (often shortened to boomers) are the demographic Demography (from prefix ''demo-'' from Ancient Greek Ancient Greek includes the forms of the Greek language used in ancient Greece and the classical antiquity, ancien ...
s into the workforce. See: Spending wave


Other factors affecting growth


Human capital

Many theoretical and empirical analyses of economic growth attribute a major role to a country's level of
human capital Human capital is a concept used by human resource professionals to designate personal attributes considered useful in the production process. It encompasses employee knowledge Knowledge is a familiarity or awareness, of someone or someth ...

human capital
, defined as the skills of the population or the work force. Human capital has been included in both neoclassical and endogenous growth models. A country's level of human capital is difficult to measure since it is created at home, at school, and on the job. Economists have attempted to measure human capital using numerous proxies, including the population's level of literacy, its level of numeracy, its level of book production/capita, its average level of formal schooling, its average test score on international tests, and its cumulative depreciated investment in formal schooling. The most commonly-used measure of human capital is the level (average years) of school attainment in a country, building upon the data development of
Robert Barro Robert Joseph Barro (born September 28, 1944) is an American macroeconomist and the Paul M. Warburg Professor of Economics at Harvard University. Barro is considered one of the founders of new classical macroeconomics, along with Robert Lucas, Jr. ...
and Jong-Wha Lee. This measure is widely used because Barro and Lee provide data for numerous countries in five-year intervals for a long period of time. One problem with the schooling attainment measure is that the amount of human capital acquired in a year of schooling is not the same at all levels of schooling and is not the same in all countries. This measure also presumes that human capital is only developed in formal schooling, contrary to the extensive evidence that families, neighborhoods, peers, and health also contribute to the development of human capital. Despite these potential limitations, Theodore Breton has shown that this measure can represent human capital in log-linear growth models because across countries GDP/adult has a log-linear relationship to average years of schooling, which is consistent with the log-linear relationship between workers' personal incomes and years of schooling in the Mincer model.
Eric Hanushek Eric Alan Hanushek (; born May 22, 1943) is an economist An economist is a professional and practitioner in the social science Social science is the branch The branches and leaves of a tree. A branch ( or , ) or tree branch (som ...
and Dennis Kimko introduced measures of students' mathematics and science skills from international assessments into growth analysis. They found that this measure of human capital was very significantly related to economic growth. Eric Hanushek and Ludger Wößmann have extended this analysis. Theodore Breton shows that the correlation between economic growth and students' average test scores in Hanushek and Wößmann's analyses is actually due to the relationship in countries with less than eight years of schooling. He shows that economic growth is not correlated with average scores in more educated countries. Hanushek and Wößmann further investigate whether the relationship of knowledge capital to economic growth is causal. They show that the level of students' cognitive skills can explain the slow growth in Latin America and the rapid growth in East Asia. Joerg Baten and Jan Luiten van Zanden employ book production per capita as a proxy for sophisticated literacy capabilities and find that "Countries with high levels of human capital formation in the 18th century initiated or participated in the industrialization process of the 19th century, whereas countries with low levels of human capital formation were unable to do so, among them many of today's Less Developed Countries such as India, Indonesia, and China."


Political institutions

“As institutions influence behavior and incentives in real life, they forge the success or failure of nations.”
In economics and economic history, the transition to
capitalism Capitalism is an economic system An economic system, or economic order, is a system A system is a group of interacting Interaction is a kind of action that occurs as two or more objects have an effect upon one another. The idea o ...

capitalism
from earlier economic systems was enabled by the adoption of government policies that facilitated commerce and gave individuals more personal and economic freedom. These included new laws favorable to the establishment of business, including contract law and laws providing for the protection of private property, and the abolishment of anti-usury laws. Much of this literature was built on the success story of the British state after the
Glorious Revolution The Glorious Revolution of November 1688 ( ga, An Réabhlóid Ghlórmhar; gd, Rèabhlaid Ghlòrmhor; cy, Chwyldro Gogoneddus), the invasion also known as the ''Glorieuze Overtocht'' or Glorious Crossing by the Dutch, was the deposition of ...
of 1688, in which high fiscal capacity combined with constraints on the power of the king generated some respect for the rule of law. However, others have questioned that this institutional formula is not so easily replicable elsewhere as a change in the Constitution—and the type of institutions created by that change—does not necessarily create a change in political power if the economic powers of that society are not aligned with the new set of rule of law institutions. In England, a dramatic increase in the state's fiscal capacity followed the creation of constraints on the crown, but elsewhere in Europe increases in
state capacityState capacity is the ability of a government to accomplish policy goals, either generally or in reference to specific aims. A state that lacks capacity is defined as a fragile state or, in a more extreme case, a failed state. There are multiple dim ...
happened before major rule of law reforms. There are many different ways through which states achieved state (fiscal) capacity and this different capacity accelerated or hindered their economic development. Thanks to the underlying homogeneity of its land and people, England was able to achieve a unified legal and fiscal system since the Middle Ages that enabled it to substantially increase the taxes it raised after 1689. On the other hand, the French experience of state building faced much stronger resistance from local feudal powers keeping it legally and fiscally fragmented until the French Revolution despite significant increases in state capacity during the seventeenth century. Furthermore, Prussia and the Habsburg empire—much more heterogeneous states than England—were able to increase state capacity during the eighteenth century without constraining the powers of the executive. Nevertheless, it is unlikely that a country will generate institutions that respect property rights and the rule of law without having had first intermediate fiscal and political institutions that create incentives for elites to support them. Many of these intermediate level institutions relied on informal private-order arrangements that combined with public-order institutions associated with states, to lay the foundations of modern rule of law states. In many poor and developing countries much land and housing are held outside the formal or legal property ownership registration system. In many urban areas the poor "invade" private or government land to build their houses, so they do not hold title to these properties. Much unregistered property is held in informal form through various property associations and other arrangements. Reasons for extra-legal ownership include excessive bureaucratic red tape in buying property and building. In some countries, it can take over 200 steps and up to 14 years to build on government land. Other causes of extra-legal property are failures to notarize transaction documents or having documents notarized but failing to have them recorded with the official agency. Not having clear legal title to property limits its potential to be used as collateral to secure loans, depriving many poor countries of one of their most important potential sources of capital. Unregistered businesses and lack of accepted accounting methods are other factors that limit potential capital. Businesses and individuals participating in unreported business activity and owners of unregistered property face costs such as bribes and pay-offs that offset much of any taxes avoided. "Democracy Does Cause Growth", according to Acemoglu et al. Specifically, "democracy increases future GDP by encouraging investment, increasing schooling, inducing economic reforms, improving public goods provision, and reducing social unrest."
UNESCO The United Nations Educational, Scientific and Cultural Organization (UNESCO) (french: Organisation des Nations unies pour l'éducation, la science et la culture) is a specialised agency United Nations Specialized Agencies are autonomous orga ...

UNESCO
and the
United Nations The United Nations (UN) is an intergovernmental organization aiming to maintain international peace and international security, security, develop friendly relations among nations, achieve international cooperation, and be a centre for harm ...

United Nations
also consider that
cultural property Cultural property does not have a universal definition, but it is commonly considered to be tangible (physical, material) items that are part of the cultural heritage Cultural heritage is the legacy of cultural resources and intangible attribut ...
protection, high-quality education, cultural diversity and social cohesion in armed conflicts are particularly necessary for qualitative growth. According to
Daron Acemoglu Kamer Daron Acemoğlu (; born September 3, 1967) is a Turkish-born Armenian Americans, Armenian-American economist who has taught at the Massachusetts Institute of Technology (MIT) since 1993. He is currently the James Rhyne Killian, Elizabeth an ...

Daron Acemoglu
, Simon Johnson and James Robinson, the positive correlation between high income and cold climate is a by-product of history. Europeans adopted very different colonization policies in different colonies, with different associated institutions. In places where these colonizers faced high mortality rates (e.g., due to the presence of tropical diseases), they could not settle permanently, and they were thus more likely to establish extractive institutions, which persisted after independence; in places where they could settle permanently (e.g. those with temperate climates), they established institutions with this objective in mind and modeled them after those in their European homelands. In these 'neo-Europes' better institutions in turn produced better development outcomes. Thus, although other economists focus on the identity or type of legal system of the colonizers to explain institutions, these authors look at the environmental conditions in the colonies to explain institutions. For instance, former colonies have inherited corrupt governments and geopolitical boundaries (set by the colonizers) that are not properly placed regarding the geographical locations of different ethnic groups, creating internal disputes and conflicts that hinder development. In another example, societies that emerged in colonies without solid native populations established better property rights and incentives for long-term investment than those where native populations were large. In ''Why Nations Fail'', Acemoglu and Robinson said that the English in North America started by trying to repeat the success of the Spanish
Conquistador Conquistadors (, ) or conquistadores (, ; meaning 'conquerors') were the invaders, knights A knight is a person granted an honorary title A title is one or more words used before or after a person's name, in certain contexts. It may sign ...

Conquistador
s in extracting wealth (especially gold and silver) from the countries they had conquered. This system repeatedly failed for the English . Their successes rested on giving land and a voice in the government to every male settler to incentivize productive labor. In Virginia it took twelve years and many deaths from starvation before the governor decided to try democracy.


Entrepreneurs and new products

Policymakers and scholars frequently emphasize the importance of entrepreneurship for economic growth. However, surprisingly few research empirically examine and quantify entrepreneurship's impact on growth. This is due to endogeneity—forces that drive economic growth also drive entrepreneurship. In other words, the empirical analysis of the impact of entrepreneurship on growth is difficult because of the joint determination of entrepreneurship and economic growth. A few papers use quasi-experimental designs, and have found that entrepreneurship and the density of small businesses indeed have a causal impact on regional growth. Another major cause of economic growth is the introduction of new products and services and the improvement of existing products. New products create demand, which is necessary to offset the decline in employment that occurs through labor-saving technology (and to a lesser extent employment declines due to savings in energy and materials). In the U.S. by 2013 about 60% of consumer spending was for goods and services that did not exist in 1869. Also, the creation of new services has been more important than invention of new goods.


Structural change

Economic growth in the U.S. and other developed countries went through phases that affected growth through changes in the labor force participation rate and the relative sizes of economic sectors. The transition from an agricultural economy to manufacturing increased the size of the sector with high output per hour (the high-productivity manufacturing sector), while reducing the size of the sector with lower output per hour (the lower productivity agricultural sector). Eventually high productivity growth in manufacturing reduced the sector size, as prices fell and employment shrank relative to other sectors. The service and government sectors, where output per hour and productivity growth is low, saw increases in their shares of the economy and employment during the 1990s. The public sector has since contracted, while the service economy expanded in the 2000s. The structural change could also be viewed from another angle. It is possible to divide real economic growth into two components: an indicator of extensive economic growth—the ‘quantitative’ GDP—and an indicator of the improvement of the quality of goods and services—the ‘qualitative’ GDP.


Growth theories


Adam Smith

Adam Smith pioneered modern economic growth and performance theory in his book ''The Wealth of Nations'' first published in 1776. The book examined the contributions to production of labor, land and capital. It demonstrated the economic importance of large buoyant markets and industrial specialization. It also documented the influence of non-economic factors such as the political-legal environment on national prosperity. Smith's study combined basic economic theory with personal observation and historical documentary references.


The Malthusian theory

The Malthusian theory proposes that over most of human history technological progress caused larger population growth but had no impact on income per capita in the long run. According to the theory, while technologically advanced economies over this epoch were characterized by higher population density, their level of income per capita was not different from those among technologically regressed society. The conceptual foundations of the Malthusian theory were formed by Thomas Malthus, and a modern representation of these approach is provided by Ashraf and Galor. In line with the predictions of the Malthusian theory, a cross-country analysis finds a significant positive effect of the technological level on population density and an insignificant effect on income per capita significantly over the years 1–1500.


Classical growth theory

In classical () economics, the theory of production and the theory of growth are based on the theory or law of variable proportions, whereby increasing either of the
factors of production In economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods a ...
(labor or capital), while holding the other constant and assuming no technological change, will increase output, but at a diminishing rate that eventually will approach zero. These concepts have their origins in
Thomas Malthus Thomas Robert Malthus (; 13/14 February 1766 – 23 December 1834) was an English cleric Clergy are formal leaders within established religion Religion is a - of designated and practices, , s, s, , , , , or , that relates humanit ...

Thomas Malthus
’s theorizing about agriculture. Malthus's examples included the number of seeds harvested relative to the number of seeds planted (capital) on a plot of land and the size of the harvest from a plot of land versus the number of workers employed. See also
Diminishing returns In economics Economics () is a social science Social science is the Branches of science, branch of science devoted to the study of society, societies and the Social relation, relationships among individuals within those societies. ...

Diminishing returns
. Criticisms of classical growth theory are that technology, an important factor in economic growth, is held constant and that
economies of scale In microeconomics Microeconomics is a branch of mainstream economics Mainstream economics is the body of knowledge, theories, and models of economics, as taught by universities worldwide, that are generally accepted by economists as a basis ...

economies of scale
are ignored. One popular theory in the 1940s was the
big push model The big push model is a concept in development economics or welfare economics that emphasizes that a firm's decision whether to industrialize or not depends on its expectation of what other firms will do. It assumes economies of scale and oligopoly, ...
, which suggested that countries needed to jump from one stage of development to another through a , in which large investments in infrastructure and education coupled with private investments would move the economy to a more productive stage, breaking free from economic paradigms appropriate to a lower productivity stage. The idea was revived and formulated rigorously, in the late 1980s by Kevin Murphy,
Andrei Shleifer Andrei Shleifer ( ; born February 20, 1961) is a Russian-American economist and Professor of Economics at Harvard University, where he has taught since 1991. Shleifer was awarded the biennial John Bates Clark Medal in 1999 for his seminal works in ...

Andrei Shleifer
and
Robert Vishny Robert Ward Vishny (born c. 1959) is an American economist and is the Myron S. Scholes Distinguished Service Professor of Finance at the University of Chicago Booth School of Business. He was the Eric J. Gleacher Distinguished Service Professor of ...
.


Solow–Swan model

Robert Solow Robert Merton Solow, Order of Prince Henry, GCIH (; born August 23, 1924) is an American economist whose work on the theory of economic growth culminated in the exogenous growth model named after him. He is currently Emeritus List of Institute Prof ...
and
Trevor Swan Trevor Winchester Swan (14 January 1918 – 15 January 1989) was an Australian economist. He is best known for his work on the Solow–Swan model, Solow–Swan growth model, published simultaneously by American economist Robert Solow, for his wo ...
developed what eventually became the main model used in growth economics in the 1950s. This model assumes that there are
diminishing returns In economics Economics () is a social science Social science is the Branches of science, branch of science devoted to the study of society, societies and the Social relation, relationships among individuals within those societies. ...

diminishing returns
to capital and labor. Capital accumulates through investment, but its level or stock continually decreases due to depreciation. Due to the diminishing returns to capital, with increases in capital/worker and absent technological progress, economic output/worker eventually reaches a point where capital per worker and economic output/worker remain constant because annual investment in capital equals annual depreciation. This condition is called the 'steady state'. In the Solow–Swan model if productivity increases through technological progress, then output/worker increases even when the economy is in the steady state. If productivity increases at a constant rate, output/worker also increases at a related steady-state rate. As a consequence, growth in the model can occur either by increasing the share of GDP invested or through technological progress. But at whatever share of GDP invested, capital/worker eventually converges on the steady state, leaving the growth rate of output/worker determined only by the rate of technological progress. As a consequence, with world technology available to all and progressing at a constant rate, all countries have the same steady state rate of growth. Each country has a different level of GDP/worker determined by the share of GDP it invests, but all countries have the same rate of economic growth. Implicitly in this model rich countries are those that have invested a high share of GDP for a long time. Poor countries can become rich by increasing the share of GDP they invest. One important prediction of the model, mostly borne out by the data, is that of ''conditional convergence''; the idea that poor countries will grow faster and catch up with rich countries as long as they have similar investment (and saving) rates and access to the same technology. The Solow–Swan model is considered an "exogenous" growth model because it does not explain why countries invest different shares of GDP in capital nor why technology improves over time. Instead, the rate of investment and the rate of technological progress are exogenous. The value of the model is that it predicts the pattern of economic growth once these two rates are specified. Its failure to explain the determinants of these rates is one of its limitations. Although the rate of investment in the model is exogenous, under certain conditions the model implicitly predicts convergence in the rates of investment across countries. In a global economy with a global financial capital market, financial capital flows to the countries with the highest return on investment. In the Solow-Swan model countries with less capital/worker (poor countries) have a higher return on investment due to the diminishing returns to capital. As a consequence, capital/worker and output/worker in a global financial capital market should converge to the same level in all countries. Since historically financial capital has not flowed to the countries with less capital/worker, the basic Solow–Swan model has a conceptual flaw. Beginning in the 1990s, this flaw has been addressed by adding additional variables to the model that can explain why some countries are less productive than others and, therefore, do not attract flows of global financial capital even though they have less (physical) capital/worker. In practice, convergence was rarely achieved. In 1957, Solow applied his model to data from the U.S. gross national product to estimate contributions. This showed that the increase in capital and labor stock only accounted for about half of the output, while the population increase adjustments to capital explained eighth. This remaining unaccounted growth output is known as the Solow Residual. Here the A of (t) "technical progress" was the reason for increased output. Nevertheless, the model still had flaws. It gave no room for policy to influence the growth rate. Few attempts were also made by the RAND Corporation the non-profit think tank and frequently visiting economist Kenneth Arrow to work out the kinks in the model. They suggested that new knowledge was indivisible and that it is endogenous with a certain fixed cost. Arrow's further explained that new knowledge obtained by firms comes from practice and built a model that "knowledge" accumulated through experience. According to Harrod, the natural growth rate is the maximum rate of growth allowed by the increase of variables like population growth, technological improvement and growth in natural resources. In fact, the natural growth rate is the highest attainable growth rate which would bring about the fullest possible employment of the resources existing in the economy.


Endogenous growth theory

Unsatisfied with the assumption of exogenous technological progress in the Solow–Swan model, economists worked to " endogenize" (i.e., explain it "from within" the models) productivity growth in the 1980s; the resulting
endogenous growth theory Endogenous growth theory holds that economic growth Economic growth can be defined as the increase or improvement in the inflation-adjusted market value of the goods and services produced by an economics, economy over time. Statisticians conv ...
, most notably advanced by Robert Lucas, Jr. and his student
Paul Romer Paul Michael Romer (born November 6, 1955) is an American economist An economist is a professional and practitioner in the social science Social science is the branch The branches and leaves of a tree. A branch ( or , ) or tre ...
, includes a mathematical explanation of technological advancement. This
model In general, a model is an informative representation of an object, person or system. The term originally denoted the plans of a building in late 16th-century English, and derived via French and Italian ultimately from Latin ''modulus'', a measure. ...
also incorporated a new concept of
human capital Human capital is a concept used by human resource professionals to designate personal attributes considered useful in the production process. It encompasses employee knowledge Knowledge is a familiarity or awareness, of someone or someth ...

human capital
, the skills and knowledge that make workers productive. Unlike
physical capital Physical capital represents in economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), production, distribution (economics), distribution, and Consumption (economi ...
, human capital has increasing rates of return. Research done in this area has focused on what increases human capital (e.g.
education Education is the process of facilitating learning, or the acquisition of knowledge, skills, value (ethics), values, morals, beliefs, habits, and personal development. Educational methods include teaching, training, storytelling, discussion ...

education
) or technological change (e.g.
innovation Innovation is the practical implementation of ideas A mental representation (or cognitive representation), in philosophy of mind Philosophy of mind is a branch of philosophy that studies the ontology and nature of the mind and its relation ...

innovation
). On Memorial Day weekend in 1988, a conference in Buffalo brought together the great minds in economics the idea was to evaluate the conflicting theories of growth. Romer, Krugman, Barro, Becker were in attendance along with many other rising stars and high profiled economists of the time. Amongst many papers that day the one that stood out was Romer's "Micro Foundations for Aggregate Technological Change." The Micro Foundation claimed that endogenous technological change had the concept of Intellectual Property imbedded and that knowledge is an input and output of production. Romer argued that outcomes to the national growth rates were significantly affected by public policy, trade activity, and intellectual property. He stressed that cumulative capital and specialization were key, and that not only population growth can increase capital of knowledge, it was human capital that is specifically trained in harvesting new ideas. While intellectual property may be important, Baker (2016) cites multiple sources claiming that "stronger patent protection seems to be associated with slower growth". That's particularly true for patents in the ethical health care industry. In effect taxpayers pay twice for new drugs and diagnostic procedures: First in tax subsidies and second for the high prices of diagnostic procedures treatments. If the results of research paid by taxpayers were placed in the public domain, Baker claims that people everywhere would be healthier, because better diagnoses and treatment would be more affordable the world over. One branch of endogenous growth theory was developed on the foundations of the Schumpeterian theory, named after the 20th-century
Austrian Austrian may refer to: * Austrians, someone from Austria or of Austrian descent ** Someone who is considered an Austrian citizen, see Austrian nationality law * Something associated with the country Austria, for example: ** Austria-Hungary ** Austr ...
economist An economist is a professional and practitioner in the social science Social science is the branch A branch ( or , ) or tree branch (sometimes referred to in botany Botany, also called , plant biology or phytology, is the s ...

economist
Joseph Schumpeter Joseph Alois Schumpeter (; February 8, 1883 – January 8, 1950) was an Austrian political economist. He was born in Moravia Moravia ( , also , ; cs, Morava ; german: link=no, Mähren ; pl, Morawy ; szl, Morawijo; la, Moravia) is a h ...
. The approach explains growth as a consequence of
innovation Innovation is the practical implementation of ideas A mental representation (or cognitive representation), in philosophy of mind Philosophy of mind is a branch of philosophy that studies the ontology and nature of the mind and its relation ...

innovation
and a process of creative destruction that captures the dual nature of technological progress: in terms of creation, entrepreneurs introduce new products or processes in the hope that they will enjoy temporary monopoly-like profits as they capture markets. In doing so, they make old technologies or products obsolete. This can be seen as an ''annulment'' of previous technologies, which makes them obsolete, and "destroys the rents generated by previous innovations". A major model that illustrates Schumpeterian growth is the .


Unified growth theory

Unified growth theory was developed by Oded Galor and his co-authors to address the inability of endogenous growth theory to explain key empirical regularities in the growth processes of individual economies and the world economy as a whole.Galor O., 2005, "From Stagnation to Growth: Unified Growth Theory". ''Handbook of Economic Growth'', Elsevier Unlike endogenous growth theory that focuses entirely on the modern growth regime and is therefore unable to explain the roots of inequality across nations, unified growth theory captures in a single framework the fundamental phases of the process of development in the course of human history: (i) the Malthusian epoch that was prevalent over most of human history, (ii) the escape from the
Malthusian trap Malthusianism is the idea that population growth is potentially exponential while the growth of the food supply Food security is a measure of the availability of food and individuals' Economic inequality, ability to access it. According the Comm ...
, (iii) the emergence of human capital as a central element in the growth process, (iv) the onset of the fertility decline, (v) the origins of the modern era of sustained economic growth, and (vi) the roots of divergence in income per capita across nations in the past two centuries. The theory suggests that during most of human existence, technological progress was offset by population growth, and living standards were near subsistence across time and space. However, the reinforcing interaction between the rate of technological progress and the size and composition of the population has gradually increased the pace of technological progress, enhancing the importance of education in the ability of individuals to adapt to the changing technological environment. The rise in the allocation of resources towards education triggered a fertility decline enabling economies to allocate a larger share of the fruits of technological progress to a steady increase in income per capita, rather than towards the growth of population, paving the way for the emergence of sustained economic growth. The theory further suggests that variations in biogeographical characteristics, as well as cultural and institutional characteristics, have generated a differential pace of transition from stagnation to growth across countries and consequently divergence in their income per capita over the past two centuries.


Inequality and growth


Theories

The prevailing views about the role of inequality in the growth process has radically shifted in the past century. The classical perspective, as expressed by Adam Smith, and others, suggests that inequality fosters the growth process. Specifically, since the aggregate saving increases with inequality due to higher property to save among the wealthy, the classical viewpoint suggests that inequality stimulates capital accumulation and therefore economic growth. The Neoclassical economics, Neoclassical perspective that is based on representative agent approach denies the role of inequality in the growth process. It suggests that while the growth process may affect inequality, income distribution has no impact on the growth process. The modern perspective which has emerged in the late 1980s suggests, in contrast, that income distribution has a significant impact on the growth process. The modern perspective, originated by Galor-Zeira model, Galor and Zeira, highlights the important role of Homogeneity and heterogeneity, heterogeneity in the determination of aggregate economic activity, and economic growth. In particular, Galor and Zeira argue that since credit markets are imperfect, inequality has an enduring impact on
human capital Human capital is a concept used by human resource professionals to designate personal attributes considered useful in the production process. It encompasses employee knowledge Knowledge is a familiarity or awareness, of someone or someth ...

human capital
formation, Aggregate income, the level of income per capita, and the growth process. In contrast to the classical paradigm, which underlined the positive implications of inequality for capital formation and economic growth, Galor and Zeira argue that Economic inequality, inequality has an adverse effect on
human capital Human capital is a concept used by human resource professionals to designate personal attributes considered useful in the production process. It encompasses employee knowledge Knowledge is a familiarity or awareness, of someone or someth ...

human capital
formation and the development process, in all but the very poor economies. Later theoretical developments have reinforced the view that inequality has an adverse effect on the growth process. Specifically, Alesina and Rodrik and Persson and Tabellini advance a political economy mechanism and argue that inequality has a negative impact on economic development since it creates a pressure for distortionary redistributive policies that have an adverse effect on investment and economic growth. In accordance with the credit market imperfection approach, a study by Roberto Perotti showed that inequality is associated with lower level of human capital formation (education, experience, apprenticeship) and higher level of fertility, while lower level of human capital is associated with lower growth and lower levels of economic growth. In contrast, his examination of the political economy channel found no support for the political economy mechanism. Consequently, the political economy perspective on the relationship between inequality and growth have been revised and later studies have established that inequality may provide an incentive for the elite to block redistributive policies and institutional changes. In particular, inequality in the distribution of land ownership provides the landed elite with an incentive to limit the mobility of rural workers by depriving them from education and by blocking the development of the industrial sector. A unified theory of inequality and growth that captures that changing role of inequality in the growth process offers a reconciliation between the conflicting predictions of classical viewpoint that maintained that inequality is beneficial for growth and the modern viewpoint that suggests that in the presence of credit market imperfections, inequality predominantly results in underinvestment in human capital and lower economic growth. This unified theory of inequality and growth, developed by Oded Galor and Omer Moav, suggests that the effect of inequality on the growth process has been reversed as human capital has replaced physical capital as the main engine of economic growth. In the initial phases of industrialization, when physical capital accumulation was the dominating source of economic growth, inequality boosted the development process by directing resources toward individuals with higher propensity to save. However, in later phases, as human capital become the main engine of economic growth, more equal distribution of income, in the presence of credit constraints, stimulated investment in human capital and economic growth. In 2013, French economist Thomas Piketty postulated that in periods when the average annual rate on return on investment in capital (''r'') exceeds the average annual growth in economic output (''g''), the rate of inequality will increase. According to Piketty, this is the case because wealth that is already held or inherited, which is expected to grow at the rate ''r'', will grow at a rate faster than wealth accumulated through labor, which is more closely tied to ''g''. An advocate of reducing inequality levels, Piketty suggests levying a global wealth tax in order to reduce the divergence in wealth caused by inequality.


Evidence: reduced form

The reduced form empirical relationship between inequality and growth was studied by Alberto Alesina and Dani Rodrik, and Torsten Persson and Guido Tabellini. They find that inequality is negatively associated with economic growth in a cross-country analysis.
Robert Barro Robert Joseph Barro (born September 28, 1944) is an American macroeconomist and the Paul M. Warburg Professor of Economics at Harvard University. Barro is considered one of the founders of new classical macroeconomics, along with Robert Lucas, Jr. ...
reexamined the reduced form relationship between inequality on economic growth in a panel of countries. He argues that there is "little overall relation between income inequality and rates of growth and investment". However, his empirical strategy limits its applicability to the understanding of the relationship between inequality and growth for several reasons. First, his regression analysis control for education, fertility, investment, and it therefore excludes, by construction, the important effect of inequality on growth via education, fertility, and investment. His findings simply imply that inequality has no direct effect on growth beyond the important indirect effects through the main channels proposed in the literature. Second, his study analyzes the effect of inequality on the average growth rate in the following 10 years. However, existing theories suggest that the effect of inequality will be observed much later, as is the case in human capital formation, for instance. Third, the empirical analysis does not account for biases that are generated by reverse causality and omitted variables. Recent papers based on superior data, find negative relationship between inequality and growth. Andrew Berg and Jonathan Ostry of the International Monetary Fund, find that "lower net inequality is robustly correlated with faster and more durable growth, controlling for the level of redistribution". Likewise, Dierk Herzer and Sebastian Vollmer find that increased income inequality reduces economic growth.


Evidence: mechanisms

The Galor-Zeira model, Galor and Zeira's model predicts that the effect of rising inequality on GDP per capita is negative in relatively rich countries but positive in poor countries. These testable predictions have been examined and confirmed empirically in recent studies. In particular, Brückner and Lederman test the prediction of the model by in the panel of countries during the period 1970–2010, by considering the impact of the interaction between the level of income inequality and the initial level of GDP per capita. In line with the predictions of the model, they find that at the 25th percentile of initial income in the world sample, a 1 percentage point increase in the Gini coefficient increases income per capita by 2.3%, whereas at the 75th percentile of initial income a 1 percentage point increase in the Gini coefficient decreases income per capita by -5.3%. Moreover, the proposed human capital mechanism that mediates the effect of inequality on growth in the Galor-Zeira model is also confirmed. Increases in income inequality increase human capital in poor countries but reduce it in high and middle-income countries. This recent support for the predictions of the Galor-Zeira model is in line with earlier findings. Roberto Perotti showed that in accordance with the credit market imperfection approach, developed by Galor and Zeira, inequality is associated with lower level of human capital formation (education, experience, apprenticeship) and higher level of fertility, while lower level of human capital is associated with lower levels of economic growth. Princeton economist Roland Benabou's finds that the growth process of Korea and the Philippines "are broadly consistent with the credit-constrained human-capital accumulation hypothesis". In addition, Andrew Berg and Jonathan Ostry suggest that inequality seems to affect growth through human capital accumulation and fertility channels. In contrast, Perotti argues that the political economy mechanism is not supported empirically. Inequality is associated with lower redistribution, and lower redistribution (under-investment in education and infrastructure) is associated with lower economic growth.


Importance of long-run growth

Over long periods of time, even small rates of exponential growth, growth, such as a 2% annual increase, have large effects. For example, the United Kingdom experienced a 1.97% average annual increase in its inflation-adjusted GDP between 1830 and 2008. In 1830, the GDP was 41,373 million pounds. It grew to 1,330,088 million pounds by 2008. A growth rate that averaged 1.97% over 178 years resulted in a 32-fold increase in GDP by 2008. The large impact of a relatively small growth rate over a long period of time is due to the power of exponential growth. The rule of 72, a mathematical result, states that if something grows at the rate of x% per year, then its level will double every 72/x years. For example, a growth rate of 2.5% per annum leads to a doubling of the GDP within 28.8 years, whilst a growth rate of 8% per year leads to a doubling of GDP within nine years. Thus, a small difference in economic growth rates between countries can result in very different standards of living for their populations if this small difference continues for many years.


Quality of life

One theory that relates economic growth with quality of life is the "Threshold Hypothesis", which states that economic growth up to a point brings with it an increase in quality of life. But at that point – called the threshold point – further economic growth can bring with it a deterioration in quality of life. This results in an upside-down-U-shaped curve, where the vertex of the curve represents the level of growth that should be targeted. Happiness has been shown to increase with GDP per capita, at least up to a level of $15,000 per person. Economic growth has the indirect potential to alleviate poverty, as a result of a simultaneous increase in employment opportunities and increased labor productivity.Claire Melamed, Renate Hartwig and Ursula Grant 2011
Jobs, growth and poverty: what do we know, what don't we know, what should we know?
London: Overseas Development Institute
A study by researchers at the Overseas Development Institute (ODI) of 24 countries that experienced growth found that in 18 cases, poverty was alleviated. In some instances, quality of life factors such as healthcare outcomes and educational attainment, as well as social and political liberties, do not improve as economic growth occurs. Productivity increases do not always lead to increased wages, as can be seen in the
United States The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country Continental United States, primarily located in North America. It consists of 50 U.S. state, states, a Washington, D.C., ...

United States
, where the gap between productivity and wages has been rising since the 1980s.


Equitable growth

While acknowledging the central role economic growth can potentially play in Human development (humanity), human development, poverty reduction and the achievement of the Millennium Development Goals, it is becoming widely understood amongst the development community that special efforts must be made to ensure poorer sections of society are able to participate in economic growth.Claire Melamed, Kate Higgins and Andy Sumner (2010
Economic growth and the MDGs
Overseas Development Institute
The effect of economic growth on poverty reduction – the growth elasticity of poverty – can depend on the existing level of inequality. For instance, with low inequality a country with a growth rate of 2% per head and 40% of its population living in poverty, can halve poverty in ten years, but a country with high inequality would take nearly 60 years to achieve the same reduction. In the words of the Secretary-General of the United Nations, Secretary General of the United Nations Ban Ki-Moon: "While economic growth is necessary, it is not sufficient for progress on reducing poverty."


Critics such as the Club of Rome argue that a narrow view of economic growth, combined with globalization, is creating a scenario where we could see a systemic collapse of our planet's natural resources. Concerns about negative environmental effects of growth have prompted some people to advocate lower levels of growth, or the abandoning of growth altogether. In academia, concepts like uneconomic growth, steady-state economy and degrowth have been developed in order to achieve this and to overcome possible growth imperatives. In politics, Green party, green parties embrace the Global Greens Charter, recognising that "... the dogma of economic growth at any cost and the excessive and wasteful use of natural resources without considering Earth's carrying capacity, are causing extreme deterioration in the environment and a massive extinction of species." The 2019 ''Global Assessment Report on Biodiversity and Ecosystem Services'' published by the

United Nations The United Nations (UN) is an intergovernmental organization aiming to maintain international peace and international security, security, develop friendly relations among nations, achieve international cooperation, and be a centre for harm ...

United Nations
' Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services warned that given the Holocene extinction, substantial loss of biodiversity, society should not focus solely on economic growth. Anthropologist Eduardo S. Brondizio, one of the co-chairs of the report, said "We need to change our narratives. Both our individual narratives that associate wasteful consumption with quality of life and with status, and the narratives of the economic systems that still consider that environmental degradation and social inequality are inevitable outcomes of economic growth. Economic growth is a means and not an end. We need to look for the quality of life of the planet." Those more optimistic about the environmental impacts of growth believe that, though localized environmental effects may occur, large-scale ecological effects are minor. The argument, as stated by commentator Julian Lincoln Simon, states that if these global-scale ecological effects exist, human ingenuity will find ways to adapt to them. Conversely Partha Dasgupta, in a 2021 report on the economics of biodiversity commissioned by the British Treasury, argues that Biodiversity loss, biodiversity is collapsing faster than at any time in human history as a result of the demands of contemporary human civilization, which "far exceed nature's capacity to supply us with the goods and services we all rely on. We would require 1.6 Earths to maintain the world's current living standards." He says that major transformative changes will be needed "akin to, or even greater than, those of the Marshall Plan," including abandoning GDP as a measure of economic success and societal progress. In 2019, a World Scientists' Warning to Humanity#2019 warning on climate change and 2021 update, warning on climate change signed by 11,000 scientists from over 150 nations said economic growth is the driving force behind the "excessive extraction of materials and overexploitation of ecosystems" and that this "must be quickly curtailed to maintain long-term sustainability of the biosphere." They add that "our goals need to shift from GDP growth and the pursuit of affluence toward sustaining ecosystems and improving human well-being by prioritizing basic needs and reducing inequality." A 2021 paper authored by top scientists in ''Frontiers in Conservation Science'' posited that given the environmental crises including biodiversity loss and climate change, and possible "ghastly future" facing humanity, there must be "fundamental changes to global capitalism," including the "abolition of perpetual economic growth."


Global warming

Up to the present, there is a close correlation between economic growth and the rate of carbon dioxide emissions across nations, although there is also a considerable divergence in carbon intensity (carbon emissions per GDP). Up to the present, there is also a direct relation between global economic wealth and the rate of global emissions. The Stern Review notes that the prediction that, "Under business as usual, global emissions will be sufficient to propel greenhouse gas concentrations to over 550 ppm by 2050 and over 650–700 ppm by the end of this century is robust to a wide range of changes in model assumptions." The scientific consensus is that planetary ecosystem functioning without incurring dangerous risks requires stabilization at 450–550 ppm. As a consequence, growth-oriented environmental economists propose government intervention into switching sources of energy production, favouring wind power, wind, solar power, solar, hydroelectric, and Nuclear power, nuclear. This would largely confine use of fossil fuels to either domestic cooking needs (such as for kerosene burners) or where carbon capture and storage technology can be cost-effective and reliable. The Stern Review, published by the United Kingdom Government in 2006, concluded that an investment of 1% of GDP (later changed to 2%) would be sufficient to avoid the worst effects of climate change, and that failure to do so could risk climate-related costs equal to 20% of GDP. Because carbon capture and storage are as yet widely unproven, and its long term effectiveness (such as in containing carbon dioxide 'leaks') unknown, and because of current costs of alternative fuels, these policy responses largely rest on faith of technological change. British conservative politician and journalist Nigel Lawson has deemed carbon emission trading an 'inefficient system of rationing'. Instead, he favours carbon taxes to make full use of the efficiency of the market. However, in order to avoid the migration of energy-intensive industries, the whole world should impose such a tax, not just Britain, Lawson pointed out. There is no point in taking the lead if nobody follows suit.


Resource constraint

Many earlier predictions of resource depletion, such as
Thomas Malthus Thomas Robert Malthus (; 13/14 February 1766 – 23 December 1834) was an English cleric Clergy are formal leaders within established religion Religion is a - of designated and practices, , s, s, , , , , or , that relates humanit ...

Thomas Malthus
' 1798 predictions about approaching famines in Europe, ''The Population Bomb'', and the Simon–Ehrlich wager (1980) have not materialized. Diminished production of most resources has not occurred so far, one reason being that advancements in technology and science have allowed some previously unavailable resources to be produced. In some cases, Substitute good, substitution of more abundant materials, such as plastics for cast metals, lowered growth of usage for some metals. In the case of the limited resource of land, famine was relieved firstly by the revolution in transportation caused by railroads and steam ships, and later by the
Green Revolution The Green Revolution, or the Third Agricultural Revolution (after the Neolithic Revolution The Neolithic Revolution, or the (First) Agricultural Revolution, was the wide-scale transition of many human culture Culture () is an umbrel ...

Green Revolution
and chemical fertilizers, especially the Haber process for ammonia synthesis.Opening line of the Preface. Resource quality is composed of a variety of factors including ore grades, location, altitude above or below sea level, proximity to railroads, highways, water supply and climate. These factors affect the capital and operating cost of extracting resources. In the case of minerals, lower grades of mineral resources are being extracted, requiring higher inputs of capital and energy for both extraction and processing. Copper ore grades have declined significantly over the last century. Another example is natural gas from shale and other low permeability rock, whose extraction requires much higher inputs of energy, capital, and materials than conventional gas in previous decades. Offshore oil and gas have exponentially increased cost as water depth increases. Some physical scientists like Sanyam Mittal regard continuous economic Exponential growth#Limitations of models, growth as unsustainable. Several factors may constrain economic growth – for example: finite, peaked, or resource depletion, depleted resources. In 1972, ''The Limits to Growth'' study modeled limitations to infinite growth; originally ridiculed, some of the predicted trends have materialized, raising concerns of an impending societal collapse, collapse or decline due to resource constraints.Turner, Graham. A Comparison of the Limits of Growth with Thirty Years of Reality. CSIRO Working Paper Series, (2010). Available at: Malthusianism, ''Malthusians'' such as William R. Catton, Jr. are skeptical of technological advances that improve resource availability. Such advances and increases in efficiency, they suggest, merely accelerate the drawing down of finite resources. Catton claims that increasing rates of resource extraction are "...stealing ravenously from the future".


Energy

Energy economic theories hold that rates of energy consumption and energy efficiency are linked causally to economic growth. The Garrett Relation holds that there has been a fixed relationship between current rates of global energy consumption and the historical accumulation of world GDP, independent of the year considered. It follows that economic growth, as represented by GDP growth, requires higher rates of energy consumption growth. Seemingly Jevons paradox, paradoxically, these are sustained through increases in energy efficiency. Increases in energy efficiency were a portion of the increase in Total factor productivity. Some of the most technologically important innovations in history involved increases in energy efficiency. These include the great improvements in efficiency of conversion of heat to work, the reuse of heat, the reduction in friction and the transmission of power, especially through electrification. There is a strong correlation between per capita electricity consumption and economic development.


Possibility of infinite economic growth

Ecological economics criticizes the possibility of infinite economic growth. Current Circular flow of income, economic models suggest the economy can grow continuously as a Perpetual motion, perpetual motion machine. However, according to the Laws of Thermodynamics perpetual motion machines do not exist.Herman Daly, Daly, Herman E., and Joshua C. Farley. Ecological Economics: Principles and Applications. Washington: Island, 2011. Print. p. 29. The First Laws says matter and energy cannot be created or destroyed, and the Second Laws says that matter and energy move from a low entropy, useful, state towards a less useful higher entropy state. Thus, no system can continue without inputs of new energy that exit as high entropy waste. Just as no animal can live on its own waste, no economy can recycle the waste it produces without the input of new energy to reproduce itself. Matter and energy enter the economy in the form of low entropy Natural capital accounting, natural capital, such as solar energy, oil wells, Fishery, fisheries, and Mining, mines. These materials and energy are used by households and firms a like to create products and wealth. After the material are used up, the energy and matter leaves the economy in the form of high entropy waste that is no longer valuable to the economy. The natural materials that power the motion of the economic system from the environment, and the waste must be absorbed by the larger ecosystem in which the economy exists. It cannot be ignored that the economy intrinsically requires natural resources and the creation of waste that must be absorbed in some manner. The economy can only continue churning if it has matter and energy to power it and the ability to absorb the waste it creates. This matter and low entropy energy and the ability to absorb waste exists in a finite amount, and thus there is a finite amount of inputs to the flow and outputs of the flow that the environment can handle, implying there is a sustainable limit to Motion (physics), motion, and therefore growth, of the economy.


Economic Growth on an Example: Republic of Armenia

Let's consider Armenia as an example to examine economic fluctuations and growth. Armenia got its independence from USSR in the year 1991. The GDP per capita of the country was only 590$. As Armenia was at war with neighbouring Azerbaijan until 1994, the economic situation in the country was not improving. In 1994, GDP per capita was 400$. The situation got much better afterwards. A big rapid economic growth occurred in the country in the 2000s due to a boom in construction. GDP per capita reached 4010$ in 2008. Due to the great recession, the value of GDP per capita declined in the year 2009 but continued rising afterwards. The final decline in GDP per capita was seen in 2020 which was resulted from the COVID-19 pandemic and the second Artsakh war. Currently, the GDP per capita of the country is 4267$.


See also

* American exceptionalism * Civilizing mission * Climate change * Degrowth * Development theory * Economic development * Export-oriented industrialization * Greed * Green growth * Green new deal * Growth accounting * The Limits to Growth * List of countries by real GDP growth rate * Manifest destiny * Orthodox Development * Post-growth * Productivism * Progress * Propaganda * Prosperity Without Growth * Status quo * Sufficiency economy * Sustainability * Sustainable development * Uneconomic growth * Unified growth theory * Universal basic income * Wealth redistribution * The White Man's Burden * World view


References


Further reading

* * Argyrous, G., Forstater, M and Mongiovi, G. (eds.) (2004) ''Growth, Distribution, And Effective Demand: Essays in Honor of Edward J. Nell''. New York: M.E. Sharpe. *Robert Barro, Barro, Robert J. (1997) ''Determinants of Economic Growth: A Cross-Country Empirical Study.'' MIT Press: Cambridge, MA. * Galor, O. (2005) ''From Stagnation to Growth: Unified Growth Theory.'' Handbook of Economic Growth, Elsevier. * Halevi, Joseph; Laibman, David and Edward J. Nell, Nell, Edward J. (eds.) (1992) Beyond the Steady State: Essays in the Revival of Growth Theory, edited with, London, UK: * * Jones, Charles I. (2002) ''Introduction to Economic Growth'' 2nd ed. W. W. Norton & Company: New York, N.Y. * Robert Lucas, Jr., Lucas, Robert E., Jr. (2003) ''The Industrial Revolution: Past and Future'', Federal Reserve Bank of Minneapolis, ''Annual Report'
online edition
* Schumpeter, Jospeph A. (1912) ''The Theory of Economic Development'' 1982 reprint, Transaction Publishers * Weil, David N. (2008) ''Economic Growth'' 2nd ed. Addison Wesley.


External links


Articles and lectures


"Economic growth."
Encyclopædia Britannic. 2007. Encyclopædia Britannica Online. 17 November 2007.

Paul Romer Paul Michael Romer (born November 6, 1955) is an American economist An economist is a professional and practitioner in the social science Social science is the branch The branches and leaves of a tree. A branch ( or , ) or tre ...
's plain-English explanation of endogenous growth theory.
CEPR Economics Seminar Series
Two seminars on the importance of growth with economists Dean Baker and Mark Weisbrot
On global economic history
by Jan Luiten van Zanden. Explores the idea of the inevitability of the Industrial Revolution.
The Economist Has No Clothes
– essay by Robert Nadeau (science historian), Robert Nadeau in Scientific American on the basic assumptions behind current economic theory * World Growth Institute. An organization dedicated to helping the developing world realize its full potential via economic growth.
Why Does Growth Keep Slowing Down? St. Louis Federal Reserve Bank


Data


Angus Maddison's Historical Dataseries
– series for almost all countries on GDP, population and GDP per capita from the year 0 up to 2003.
OECD economic growth statistics


- easy to use dataset showing GDP, per capita and population, by country and region, 1970 to 2008. Updated regularly. {{DEFAULTSORT:Growth Economic growth, Economic development Macroeconomic indicators