Economic Growth

‘Is there some action a government of India could take that would lead the Indian Economy to grow like Indonesia’s or Egypt’s? If so, what, exactly? If not, what is it about the ‘nature of India’ that makes it so? The consequences for human welfare involved in questions like these are simply staggering: once one starts to think about them, it is hard to think about anything else.’*
-Robert Lucas, Nobel Laureate; Marshall Lectures, University of Cambridge 1985

Photo by canonsnapper on Flickr

With these words, the Economics Nobel Prize Winner Robert Lucas started what was to become a seminal contribution to our understanding of economic growth. After languishing for many years at the bottom of the research agenda, in the last decade or so the field of economic growth has reawakened. Today economic growth has become central to the study of macroeconomics. Economists have come to understand that long-run growth is as important (perhaps even more important) than short-run fluctuations.

The newspapers are filled with accounts of monthly changes in industrial production and retail sales. But these short-run changes have a relatively minor impact on economic well-being. Why GDP rose or fell a few percent over the last three months can be an intriguing question. Even more significant, however, is why the United Kingdom is so much richer than Uganda; or why growth in UK income over the past quarter-century has been slower than growth over the previous quarter-century.

Growth theory investigates the factors that drive a country’s long-run growth in GDP per capita. The accumulation of input factors such as capital and labour are central to the growth process. But a simple accumulation of a single input factor is likely to lead to diminishing returns and, eventually, to a halt in long-run growth.

So what does drive long-run growth? Diminishing returns can be defeated by increases in productivity triggered by factors such as technological change and better skills and education. More generally, any factor that can increase the productivity of input factors can lead to a sustained rise in income, and is a candidate for policy intervention. Hence, for example, a well-developed financial system is important in channelling savings to investment activities; trade can induce specialisation and enhance productivity; a more equal distribution of income creates incentives for working harder; good infrastructure (transportation, communication, etc.) makes production more efficient.

The study of economic growth provides you with both a theoretical and empirical understanding of how all these factors (‘ingredients’) combine together to provide the right recipe for a country’s long-run growth.

*India’s economic growth in recent years has been remarkable. The interesting question then becomes: what triggered it? And will it be sustainable?

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