Economic Growth

Economic growth is defined as increases in per capita real GDP over time(percent change in real GDP-percent change in population). Recently, annual real GDP growth has been around 3% in the United States, while population growth has remained around 1%, making economic growth approximately 2%. A satisfactory rate of economic growth is one of the six economic goals(along with full employment of factors of production, price stability, freer trade with other nations, "correct" distribution of income, and efficient allocation of resources). According to most economists, a "satisfactory" rate lies somewhere between 1 and 1.5%. This is difficult for many countries to maintain because they have larger population growth rates than we do(some as high as 3-5%).

Economic growth is important for several reasons. Primarily, it improves the overall standard of living for individuals in a country. Additionally, economic growth is one way to reduce poverty in an economy and possibly worldwide if the economy is big enough and therefore influential enough.

Economic growth is maintained by technological change, or Total Factor Productivity. Economist Robert Solow worked on this concept in the 1950s with his neo-classical economic growth model. Output(real GDP) is a function of technological change, stock of capital, and the total population. Therefore, to increase real GDP, a positive change in the stock of capital and population control is necessary. To increase investment spending on capital, savings must be increased. Savings have three sources: households(personal savings), businesses(retained earnings), and the government(budgetary balance). 401ks and IRAs boost savings, thereby increasing investment spending, and leading to positive changes in capital and economic growth. Similarly, investment tax credits encourage business savings and investment.

With the desire to increase capital investment, comes the question: Should governments decide capital projects? The answer is yes, in some cases, they should because they have to. Projects such as roads, bridges, and the educational system must be government capital because individuals won't provide or build those things on their own.

Population control and enhancement can be costly for some countries but aids in economic growth. Population growth must be controlled to a manageable level at which per capita economic growth is feasible. Investing in human capital through higher education breeds more productive workers, increasing the output of the economy. A more educated and specialized economy is able to produce more with the same amount of resources because the quality of their resources has improved.

Technology, as mentioned earlier, can increase economic growth. New and/or improved technology arises from research and development. R&D includes basic research, which is government sponsored via the National Science Foundation and others, and applied research, which is conducted by firms and private businesses. Technological research can be expensive, thus we have 17 year patents that protect intellectual property rights and serve as incentives to invest in research. Unfortunately, some countries do not honor the patents of other countries(historically, China has not honored many of the United States' patents). There exist two types of technological change: embodied, which requires new capital to implement, and disembodied, for which no new capital is necessary.

So what role does the government play in promoting economic growth? Governments act to influence capital, population, and technology. To increase capital investment, they need to increase levels of savings or maintain already high levels. The US government offers IRAs, 401ks, Roth IRAs, and others to encourage personal saving. The government also ensures transparency in financial markets (as much as possible) through the SEC (Securities Exchange Commission) and the CFTC (Commodity Future Trading Commission), among others. The more uncertain people are about the financial markets, the less likely they are to invest in them. Governments also try to keep budget deficits low, to avoid a worse budgetary balance, and to help the economy grow without being held back by such a large debt. To influence population, governments provide human capital investment (education and training). Finally, the government sponsors research for technology and gives tax credits to businesses for conducting technological research.

There are some additional factors which promote economic growth. The first is free markets, which drive economic efficiency, allowing for maximum output in the economy. Freer trade, advocated most famously by Adam Smith, allows for optimal economic growth because it also implies economic efficiency. Protection of private property (such as through patents), "Free Press," and minimal graft and corruption(especially in governments) are all vital factors for economic growth in a country.