What Is Economic Growth? - The Balance

Economic growth is the increase in the value of an economy's goods and services, which creates more profit for businesses. As a result, stock prices rise. That ... US&WorldEconomies EconomicTerms Partof UnderstandingGDP GDPDefinition&Formula TheComponentsofGDP U.S.GDPbyYear WhatisRealGDP? GDPPerCapita RealGDPPerCapita GDPGrowthRate MeasuringEconomicGrowth GDPGrowthRatevs.UnemploymentRate WhatIsEconomicGrowth? EconomicGrowthExplained TableofContents Expand TableofContents Definitions&ExamplesofEconomicGrowth HowDoesEconomicGrowthWork? WaystoSpurEconomicGrowth By KimberlyAmadeo FullBio LinkedIn KimberlyAmadeoisanexpertonU.S.andworldeconomiesandinvesting,withover20yearsofexperienceineconomicanalysisandbusinessstrategy.SheisthePresidentoftheeconomicwebsiteWorldMoneyWatch.AsawriterforTheBalance,Kimberlyprovidesinsightonthestateofthepresent-dayeconomy,aswellaspasteventsthathavehadalastingimpact. Learnaboutour editorialpolicies UpdatedOctober24,2021 Reviewedby MichaelJBoyle Reviewedby MichaelJBoyle FullBio MichaelBoyleisanexperiencedfinancialprofessionalwithmorethan10yearsworkingwithfinancialplanning,derivatives,equities,fixedincome,projectmanagement,andanalytics. Learnaboutour FinancialReviewBoard TheBalance/EvanPolenghi Economicgrowthisanincreaseintheproductionofgoodsandservicesoveraspecificperiod.Tobemostaccurate,themeasurementmustremovetheeffectsofinflation. Learnwhyallcountrieswanteconomicgrowth,howgrowthismeasured,andwhichfactorsdriveproduction. DefinitionsandExamplesofEconomicGrowth Economicgrowthistheincreaseinthevalueofaneconomy'sgoodsandservices,whichcreatesmoreprofitforbusinesses.Asaresult,stockpricesrise.Thatgivescompanies capital toinvestandhiremoreemployees. Asmorejobsarecreated,incomesrise.Consumershavemoremoneytobuyadditionalproductsandservices,andpurchasesdrivehighergrowth.Forthisreason,allcountrieswantpositiveeconomicgrowth.Thismakeseconomicgrowththemost-watchedeconomicindicator. HowDoesEconomicGrowthWork? Grossdomesticproduct isthebestwaytomeasureeconomicgrowthbecauseittakesintoaccountthe country'sentireeconomicoutput.GDPincludesallgoodsandservicesthatbusinessesinthecountryproduceforsale.Itdoesn'tmatterwhethertheyaresolddomesticallyoroverseas. GDPmeasuresfinalproduction.Itdoesn'tincludethepartsthataremanufacturedtomakeaproduct.GDPincludes exports becausetheyareproducedinthecountry. Imports aresubtractedfromeconomicgrowth. Mostcountriesmeasureeconomicgrowtheachquarter. Themostaccuratemeasurementofgrowthis realGDPwhichremoves the effectsofinflation.The GDPgrowthrate usesrealGDP. TheWorldBankusesgrossnationalincomeinsteadofGDPtomeasuregrowth.Itincludesincomesentbackbycitizenswhoareworkingoverseas.It'sacriticalsourceofincomeformany emergingmarketcountrieslikeMexico.ComparisonsofGDPbycountrywillunderstatethesizeofthesecountries'economies. WhatGDPDoes(andDoesNot)Include GDPdoesn'tinclude unpaidservices.Itleavesoutchildcare,unpaidvolunteerwork,orillegal black-marketactivities.Italsodoesn'tcounttheenvironmentalcosts.Forexample,thepriceof plasticis cheapbecauseitdoesn'tincludethecostofdisposal. Asa result,GDPdoesn'tmeasurehowthesecosts impact thewell-beingofsociety. Acountrywillimproveits standardofliving when itfactorsinenvironmentalcosts.Asocietyonlymeasures whatitvalues.  Similarly,societiesonlyvaluewhattheymeasure.Forexample, Nordiccountries rankhighintheWorldEconomicForum's GlobalCompetitivenessReport. Theirbudgetsfocusonthedriversofeconomicgrowthwhichareworld-classeducation,socialprograms,andahighstandardofliving.Thesefactorscreateaskilledandmotivated workforce. Thesecountrieshaveahightaxrate.Buttheyusethe revenues toinvestinthelong-termbuildingblocksofeconomicgrowth. Riane Eisler'sbook, “TheRealWealthofNations,”proposeschangestotheU.S.economicsystembygivingvaluetoactivitiesattheindividual,societal,andenvironmentallevels. ThiseconomicpolicycontrastswiththatoftheUnitedStates.Ituses debttofinanceshort-termgrowththroughboostingconsumerandmilitaryspending.That'sbecausetheseactivitiesdoshowupinGDP.  ThePhasesofEconomicGrowth Analystswatcheconomicgrowthtodiscover whatstageofthe businesscycle theeconomyisin.Thebestphaseis expansion.Thisiswhentheeconomyisgrowinginasustainablefashion.Ifgrowthistoofarbeyondahealthygrowthrate,itoverheats.Thatcreatesan assetbubblewhichiswhathappenedtothehousingsectorin2005-2006.Astoomuchmoneychasestoofewgoodsandservices, inflation kicksin.Thisisthe"peak"phaseinthebusinesscycle. Atsomepoint,confidenceineconomicgrowthdissipates.Whenmorepeoplesellthanbuy,theeconomy contracts.Whenthatphaseofthebusinesscyclecontinues,itbecomes a recession.Aneconomicdepressionisarecessionthatlastsforadecade.Theonlytimethishappenedwasduring theGreatDepressionof1929. ThechartbelowshowsthedifferentphasesoftheU.S.economyfromQ42005throughQ12021. CausesofU.S.Growth TheUnitedStateshasanabundanceofthefourfactorsofproduction.Theseareland/naturalresources,labor,capitalequipment,andentrepreneurship. TheUnitedStates’largelandmasscomparestothoseof Russia,Canada,andAustralia.Butithasmorenaturalresourcesthanthesecountries.Thebestoftheseare: TillablesoilintheGreatPlainsoftencalledthebreadbasketoftheworldAtemperateclimateFreshwater,lakes,andriversLargedepositsofoil,coal,andnaturalgas CanadaandRussiaarethwartedbyacoldclimate.Australiaisdry. Thesenaturalresourcesattractedlabor.Asaresult,theU.S.laborforceislarge,skilled,andmobile.Itrespondsquicklytochangingbusinessneeds.Thelargeanddiversepopulationprovidesahome-growntestmarket.Itgivesdomesticcompaniesexperienceinknowingwhatconsumerswant.ThishasgiventheUnitedStatesa comparativeadvantage inproducingconsumerproducts.Asaresult,almost70%ofwhatthe countryproducesisforpersonalconsumption. Economicgrowthhasalsobeendrivenbyproductivitygains.Thatmeasureshowmucheachhourofworkertimeproducesinoutput.Itsfree-marketeconomyencouragestechnologicalinnovations.  AllofthesegiveU.S.companiesanadvantageinexporting.Asaresult,theUnitedStatesistheworld'ssecond-largestexporter. Ithasallowedthecountrytoexcelinproducingthefourthfactorofproduction,capitalequipment.Theseincludecomputers,semiconductors,andmedicalequipment.Italsoincludes industrialmachineryandequipment. TheU.S.servicesindustryisalsoinnovative.Themostsuccessfulare financialservices,healthcare,andintellectualpropertysuchascomputersoftware. WaystoSpurEconomicGrowth Ifacountryisnotblessedwiththefactorsofproduction,itmustfindotherwaystospurgrowth.Governmentswanttoincreasegrowthbecauseitincreases taxrevenue.Growthallowsbusinessestohireworkers,increasingtheirincome.Whenpeoplefeelprosperous,theyrewardpoliticalleadersbyre-electingthem. Thegovernmentstimulatesgrowthwith expansivefiscalpolicy.Iteitherspendsmore,cutstaxes,orboth.Sincepoliticianswanttogetre-elected,theyuseexpansivefiscalpolicytostimulatetheeconomy. Butexpansivefiscalpolicyisaddictive.Ifthegovernmentkeepsspendingmoreandtaxingless,itleadsto deficitspending.Itworksforawhilebuteventuallyleadstohigherdebtlevels.Intime,asthe debt-to-GDPratio approaches100%,itslowseconomicgrowth.Foreigninvestorsstopinvestingfundsinacountrywithahighdebtratio.Theyworrytheywon'tgetrepaidorthatthemoneywillbeworthless. Governmentsshouldthenbecarefulwithexpansive fiscalpolicyandshouldonlyuseitwhentheeconomyisincontractionorrecession.Whentheeconomyisgrowing,itsleadersshouldcutbackspendingandraisetaxes.Thisconservativefiscalpolicyensuresthateconomicgrowthwillremainsustainable. Anation'scentralbankcanalsospurgrowthwithmonetarypolicy.Itcanincreasethe moneysupplybylowerinterestrates.Banks makeloansforauto,school,andhomeslessexpensive.Theyalsoreduce creditcardinterestrates.Alloftheseboost consumerspendingandeconomicgrowth. KeyTakeaways Economicgrowthistheincreaseinthevalueofaneconomy'sgoodsandservicesovertime.Realgrossdomesticproduct isthebestwaytomeasureeconomicgrowth,becauseitremovestheeffectsofinflation.Thegovernmentstimulatesgrowthwith expansivefiscalpolicybyspendingmoreorcuttingtaxes.Overtime,expansivefiscalpolicycanleadtodeficitspending,higherdebtlevels,andslowingeconomicgrowth. ArticleSources CongressionalResearchService."IntroductiontotheU.S.Economy:GDPandEconomicGrowth."AccessedJune30,2021. AmericanInstituteforEconomicResearch."YourGuidetoUnderstandingRealvs.NominalGDP."AccessedJune30,2021. TheWorldBank."WhyCan'tIFindEstimatesofGrossNationalProduct(GNP)?"AccessedJune30,2021. WorldEconomicForum."GlobalCompetitivenessReportSpecialEdition2020:HowCountriesArePerformingontheRoadtoRecovery."AccessedJune30,2021. RianeEisler."TheRealWealthofNations:CreatingaCaringEconomics."Berrett-KoehlerPublishers,Inc.,2007. JaneDokko, BrianDoyle, MichaelT.Kiley,JinillKim, ShaneSherlund, JaeSim,and SkanderVandenHeuvel."MonetaryPolicyandtheHousingBubble,"FinanceandEconomicsDiscussionSeries(FEDS).AccessedJune30,2021. UniversityofMinnesotaLibraries."PrinciplesofEconomics:2.1FactorsofProduction."AccessedJune30,2021. FederalReserveBankofSt.Louis."SharesofGrossDomesticProduct:PersonalConsumptionExpenditures."AccessedJune30,2021. Statista."LeadingExportCountriesWorldwidein2020."AccessedJune30,2021. EconomicsandStatisticsAdministration."IntellectualPropertyandtheU.S.Economy:IndustriesinFocus,"Page7.AccessedJune30,2021. FederalReserveBankofSt.Louis."Debt-to-GDPRatio:HowHighIsTooHigh?ItDepends."AccessedJune30,2021. Share Tweet Share Email PartOf UnderstandingGDP GDP:UnderstandingaCountry'sGrossDomesticProduct 1of9 4CriticalComponentsofAmerica'sEconomicGrowth 2of9 AnAnnualReviewoftheU.S.EconomySince1929 3of9 WhatMakesRealGDPSoIncrediblyReal? 4of9 WhatIsGDPPerCapita? 5of9 WhatRealGDPperCapitaRevealsAboutYourLifestyle 6of9 HowToCalculatetheGDPGrowthRate 7of9 WhatIsEconomicGrowth? 8of9 USRealGDPGrowthRatebyYearComparedtoInflationandUnemployment 9of9 WhatIsFiscalDrag? WhatAreCapitalGoods? WhatIstheBusinessCycle? 5U.S.GDPStatisticsYouNeedtoKnow Where'stheBestStandardofLiving?ItDependsWhomYouAsk 4CriticalComponentsofAmerica'sEconomicGrowth WhatReallyMakestheWorldGo'Round WhatIstheIdealGDPGrowthRate? TheU.S.NationalDebtandHowItAffectsYou WhatIsGDPPerCapita? USInflationRatebyYear:1929-2023 HowToCalculatetheGDPGrowthRate WhatExactlyIstheU.S.Economy? UnemploymentRatebyYearSince1929ComparedtoInflationandGDP WhatIstheDebt-to-GDPRatio? WhatIsaRecession?