microeconomics

What factors affect economics growth.what factor are most important at an international and national level.

Tax, competition, market, capital, monopoly, trade and price you can discuss to explain this statement

Harvard style reference, 2500 words , illustrate graph where necessary

SOLUTION

Microeconomics: What factors affect economics growth.what factor is most important at an international and national level.

Table of Contents

INTRODUTCION.. 2

LITERARTURE REVIEW… 2

FACTORS AFFECTING ECONOMIC GROWTH.. 4

CONCLUSION.. 10

REFERENCES AND BIBLIOGRAPHY.. 11

INTRODUTCION

An increase in real GDP is called economic growth. Annual percentage increase in GDP is the measurement of rate of economic growth. Economic growth indicates an increase in the value of goods and services. There are several factors which impact economic growth of a country. The impact of factors varies country to country. Even within country the most important factor varies over time. The factor which is very important for growth many not remain so important in future. There is no country which is affected by just one or two factors rather there are many factors that work together and influence the growth rate, though the severity varies across countries and time. The understanding of these factors leads to search for solution to low growth or frequent fluctuations in the growth. The present study aims to understand the factors affecting economic growth of an economy. We will try to understand the process of any factor’s influence on economic growth. There have been numerous studies trying to find empirical evidences of relationship between economic growth and the factors influencing it. Here I will review some of such studies as follows.

LITERARTURE REVIEW

Borensztein, Gregorio, Lee(1998) studied data of 69 developed countries and found that FDI (Foreign Direct Investment ) affects economic growth in a substantial manner . It is an important vehicle of technology and capital transfer. But they also found that FDI affects the economy in a positive way only if the host economy has sufficient human capital and other resources like infrastructure, technological advances etc.  The countries which cannot support FDI by providing other resources cannot reap full benefits of it. Therefore, the role of other resources is very important in FDI’s impact on economic growth. The developed countries are more benefited by FDI due to high availability of human capital either from own country or from other developing countries migrants. Nelson and Phelps (1966), and Benhabib and Spiegel (1994) also argued same.

Adam Smith’ (1776) argued specialization or division of labor improves the productivity which leads to higher economic growth.

Joseph Schumpeter (1912) said higher bank funding to entrepreneurs leads to higher growth in the economy. LEVIN (1997) empirically test the role of financial factors in economic growth. He found financial markets and other financial institutions play an important role in economic growth. The author also claimed that the transaction costs, information acquisition cost in financial market affects economic growth by influencing the number and amount of transactions in an economy. Kenneth Arrow (1964) also expressed the same view as Levin (1997). Levin (1997) puts the process of economic growth and the relationship of financial development and economic growth is a very systematic way such as financial markets’ functions are to mobilize the savings. Allocate the funds, risk management all are the channels of economic growth. The author stated that functions of financial markets are highly affected by transaction costs and information costs. Quigley (1998) studied the impact of urban diversity on economic growth of the countries. He found a significant relationship between these two variables. Zak and Park (2000) studied relationship between social institutions such as income and genetic attributes, income inequality and their impact on economic growth . They found a significant impact of social institutions on economic growth.

The following graph shows relationship between growth measured in terms of real GDP and the inflation rate which is measured in terms of CPI.

Economic Growth in UK

FACTORS AFFECTING ECONOMIC GROWTH

The following are the factors affecting economic growth of a country:

1. Capital

Capital of a country includes the supply or availability of durable goods produced by human labour and used in the production process to enhance the productivity. Example of these goods or capital is machines, equipments etc. Capital is a production factor or input of production. The capital goods are not completely consumed but they may get depreciated over a period of time as it is used in the production.

Capital of a country affects its economic growth by expediting or lowering the production process. In developed countries like UK and USA availability of capital increases the rate of production per unit of input .which results in larger amount of production while other factors of production remaining constant. Thus higher amount of Capital leads to higher economic growth.

2. Technology Infrastructure and the Technological Know-how

The supply of technology in the production process makes it faster. In fact many without basic infrastructure many goods and services cannot be produced at all. For instance, Doctors cannot perform the surgeries without basic technology infrastructure, and producing for goods also the technological infrastructure is required. Like Japan’s fast economic growth can be attributed to its technological progress in terms of availability of advanced machines, equipments and technology know how. Thus technology plays an important role in a country’s economic growth (Romer 1990, Segerstrom, 1991, Nelson&Phleps, 1966)

3.  Investment

The amount of investment in a country affects its economic growth and it is stated by many researchers in the economics that investment is the most important factor of economic growth. That is why in every year’s annual budget most of the focus is on investment, the total investment of a country includes investment by an individual, by the business firms, by Government or the major categories are public and private investment. Every Government want to increase investment in the country, but the pattern of investment depends on the need of the country like which sector needs more investment for welfare of the economy. For instance, in India more emphasis is given on the sectors like agriculture, floriculture, textile industry etc. The Government want to lead pump priming effect of Government investment such as providing basic infrastructure for a industry which attracts private players in the industry or sector.

Investment increases the production inputs which results in higher productivity if scale of return is increasing or economies of scale are reaped well. Thus higher investment leads to higher production rate and eventually higher economic growth.

The following graph shows relationship between saving, investment and economic growth rate.

Source: www.rbi.org

4. Health

The poor health or health diseases reduce the working population or decreases the rate of production which causes lower economic growth. Thus good health or higher standard of living leads to higher economic growth. This factors affects the economic growth from two ways like one is from production side by influencing the working population and the other is consumption side , higher consumption leads to higher demand and then higher economic growth. The healthy population can produce more and also consumes more, eventually leading to higher economic growth.

5. Interest Rates

Interest rates affect the economic growth of a country. The interest rates are managed by the central banks of a country. Interest rates are a tool of monetary policy and used for controlling the inflation, deflation. Inflation rates influences the economic growth by its impact of investment and consumption. If the inflation rate is higher that means purchasing power of the money has decreased due to its excess supply in the economy. In that situation interest rates are increased  which causes reduction in the consumption of durable goods like goods which are mostly purchased by financing for example motor vehicle, houses etc. and also the increased interest rates leads a reduction in the production of durable goods due to decreased demand and increased cost of capital. Thus interest rate affects economic growth of a country.

6. Currency Strength

Currency is an important economic factor which influences economic growth of an open economy and also of close economy, though the impact of currency strength or weakness is higher on an open economy. The open economy is directly and immediately affected by any movement in any currency rate. The value of currency or exchange rate affects imports and exports of the country which causes impact on economic growth. Its impact can be understood as an increase in the value of currency or appreciation in the currency value or decrease in currency rate makes domestic prices competitive which increases the exports but also causes losses to them. Thus favourable movement in the currency is good for economic growth.

7. Government Intervention

The Government of a country controls and monitors all the industries in an economy but some industries are heavily regulated in the best interest of the country. For example ,employees safety in highly risky industries and customers safety by regulating the consumer goods industries such as food industry where certain standard are generally set to maintain the food quality. Thus Government interventions help in bringing desired growth pattern in the economy which results in maximum benefits from it. Thus Government interventions  affects the economic growth of an economy.

8. Environmental Impact

The economic growth of a country is also affected by environmental consequences. The environmental consequences from producing goods and services not only affects the produced goods and services but also has a great impact on the demand of the produced goods and services by affecting consumers’ perception  about the impact of it on society. For instance, many religious people do not use leather goods and fur goods because they believe keeling animals for their production is inhumane, hence demand for these products get affected. Thus economic growth gets affected by environmental impact.

9. Economic State of the Economy or Economic Health

The economic growth is affected by the existing state of the economy. It recessionary phase consumers cut their production and shifts from luxuries goods to basic goods. It reduces production and also changes the production pattern. This whole process results in changes economic variables and eventually changes in economic growth. For instance, during World recession in 2008-2010 and again in 2011 caused a speedy decline in economic growth of most of the countries and global economy’s growth rate as a whole also declined. Similarly, during peak or recovery phase , production starts increasing due to high demand leading to a favourable environment in the economy. Thus it can be said that state of an economy causes changes in the economic growth of a country or economy.

10. Consumer Confidence:

(Romer 1993)Consumer confidence is a qualitative factor which affects an economy and its growth rate in an indirect way. High confidence of consumers in the future state of the economy or their expectations that the economy will grow more or remain stable in growth phase in future ,makes them to borrow and spend more . It results in high growth of the economy. Whereas when consumers are pessimistic about future state of the economy they starts saving in the present time, they cut their consumptions ,producers start cutting the production to meet the reduced demand from consumers, this whole process causes reduction in investment, production and consumption and then leading to slow economic growth rate. This is what happened during 2011 when Greece and other European countries’ consumers lost their phase in the economy other economies all over the world lost their faith in their economies. Thus consumer confidence affects economic growth rate.

11. Asset Prices :

These assets are real assets like home, land etc. If home prices start increasing people start remortgaging their rising property value and they increase their present consumption. Sub-prime crisis in 2008 is an example of influence of housing prices on economic growth. The asset price effect is more in those countries where people invest more in real estates.

12. Real Wages:

When inflation is high then real wages are very less than the nominal wages. Low real wages reduces real purchasing power of the consumers and they start cutting down their consumptions. The reduced consumption leads to reduction in the production and the economy turns into recessionary phase or the growth rate starts lowering down.

13. Banking sector:

If banking sector loses money and not willing to lend it causes difficulty for firms and consumers leading to slow growth rate in the economy.

14. Level of economic infrastructure:

Economic infrastructure such as roads, lights etc are the basic necessities of business and their availability attracts many new entrants and increases efficiencies of existing  firms also.  The increased investment results in higher economic growth.

15. Level of social infrastructure

The social infrastructure of an economy such as education level, medical facilities etc., affects the productivity and consumption level of an economy. High level of social infrastructure increases the growth of an economy whereas low level reduces the growth rate of an economy.

16. Commodity prices

The commodity prices affects economic growth in short term. For instance, increase in prices of oil which is an important input of an economic activity causes a shock to the economic growth. Similarly, increase in food prices and prices causes increase in inflation which leads to controlled interest rates that are increasing interest rates and which results in reduced consumption, investment and production. Thus commodity prices affects economic growth rate.

17. Political Instability

Political instabilities such as change in the Government, conflict of interest between ruling parties, improper decision making leads to risk in the business and reduces investors confidence in an economy. Not only domestic investors sentiments get affected by political instability but also foreign investors always look for political stability in an economy. For example, due to political instability in India investors claiming that they do not want to take risk by investing in India. The Cairn-Vedanta deal was a big issue of political instability, similarly FDP in retail in India was a recent issue where FDP was not being allowed by opposition parties that situation created negative sentiments in the economy and foreign investors took it in a very negative way of India’s political decision making.

18. Weather

The intensity or severity of summer or cold causes harm to crops and many other businesses. It also harms day to day activities of people. Sometime unexpected weather such long summers in India causes harm to crops. Thus weather also affects economic growth.

19. Government Spending

When the Government spends more it gives pump priming effect to private sectors as the government spending increases basic infrastructure in the economy which attracts many private investors and also increase efficiency and productivity of the business. Thus higher Government spending increases economic growth rate. Specially developed countries need higher Government spending.

20. Tax policy

The tax policy of an economy affects its economic growth by increasing or decreasing the investment by business firms and also it depends on use of the taxation amount by the Government. If the Government spends tax amount on increasing productivity then it leads to higher growth.

21. Competition level

A fair level of competition makes favourable business conditions in the economy and the it increases production,wages,income and consumption leading to higher growth rate.

CONCLUSION

Thus as above explained there are numerous factors affecting economic growth. For example the negative growth of 1981 in UK was because of high interest rates, low spending by the government and appreciation in pounds made exports costly , whereas negative growth of UK in 1991 was because of high confidence of the consumers, high wages, low interest rates, high housing prices. Thus many factors can influence together and combination and severity of factors varies over time and across countries.

REFERENCES

Borensztein, E. Gregorio, J. De & Lee, J-W(1998). How does foreign direct investment affect economic growth. Journal of International Economics 45 (1998) 115–135

Benhabib, J., Spiegel, M., 1994. The roles of human capital in economic development: evidence from aggregate cross-country data. Journal of Monetary Economics 34, 143–173.

LEVIN, R.(1997). Financial Development and Economic Growth: vi6ws and Agenda. Journal of Economic Literature Vol. XXXV (June 1QQ7), pp. 688-726.

Nelson, R., Phelps, E., 1966. Investment in humans, technological diffusion, and economic growth. American Economic Review: Papers and Proceedings 61, 69 – 75.

Romer, P., 1990. Endogenous technological change. Journal of Political Economy 98, S71–S102.

Romer, P., 1993. Idea gaps and object gaps in economic development. Journal of Monetary Economics 32, 543–573.

Segerstrom, P.S., 1991. Innovation, imitation, and economic growth. Journal of Political Economy 99, 807–827.

United Nations, 1992. World Investment Report 1992 Transnational Corporations as Engines of Growth, Department of Economic and Social Development, United Nations, New York.

Quigley, J.M. (1998).Urban diversity and economic growth. The Journal of Economic Perspectives.Vol.12,No, 2,127-138.

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