Definition of economic growth: The rate of increase in the value of goods and services produced by an economy.
What is economic growth?
In the simplest sense, economic growth is achieved when a country can produce more goods and services than it could last year.
Economic output is commonly measured as Gross Domestic Product. Therefore economic growth is measured as a percentage increase in GDP, typically year on year or quarter against the same quarter last year.
The best economics books will explain how economic growth is practically calculated.
What is a good rate of economic growth?
Developed economies tend to see lower rates of economic growth than less developed economies such as the emerging markets. A good rate of growth for a large, mature economy such as the United States would be 2% – 3% per year.
Emerging markets have been known to grow at rates of 5% – 10% per year during economic booms.
This is assisted in part by the flow of inward investment from other economies. Investors are happy to diversify internationally and invest in higher-risk economies in the hope of achieving higher returns. This movement of capital, motivated entirely out of self-interest, results in more construction, more capital expenditure and higher economic growth in the recipient’s economy.
This feeds a self-fulfilling prophecy which sees the growth of the highest performing economies turbocharged.
Why do economies grow?
Although its patently obvious that economic growth brings benefits such as improved standards of living, lower food poverty and increases in the tax base, it’s less obvious why economies grow at all.
Economic growth seems like it’s almost an inevitable consequence of capitalism. But why?
The answer to the question “Why do economies grow” is the same as the question “Why do companies grow?”. What happens at the national level is merely a sum of all the economic activity of the smaller enterprises which comprise it.
There are many reasons why economies grow, which generally fit into these two headings:
- There are more workers
- We can make more products with fewer workers
The birth rate and inward migration mean that the number of working adults in the UK has steadily increased over the last hundred years. This means that as time rolls on, more hands are available to produce.
We also become more efficient at producing goods with fewer resources. This means that given the same constraints (i.e. money, workforce) we are still able to produce a higher quantity of goods year-on-year. Here are some reasons why:
- Better ways of working. The way we do things improves all the time. Great ideas and effective ways to run businesses are shared through books, higher education, and employees moving between businesses.
2. Capital expenditure – We don’t just consume everything we produce – we also invest some of the proceeds back into buildings, equipment and software which can help build more products at a lower cost next year.
3. Consumers crave more – Consumers help to drive economic growth by demanding more and more each year. Whether it’s a newer, shinier phone or a larger house, our human desire to ever-improve our circumstances means that businesses find more and more new products and services have a viable market each year.
4. Technology improves at an exponential rate. The computing power of computers doubles once every two years. Software becomes more and more user friendly. One technology platform – e.g. satellite navigation enables another technology platform e.g. ride hailing apps, in a continuous loop of improvement in capability and ease of use.
How is the phrase economic growth used in a sentence?
“The UK has swung back into economic growth, reporting a rise in GDP by 2.1% annually.”
“The fiscal conservatism in the 2021 Budget has resulted in a slow down in economic growth.”
How does the definition of economic growth relate to investing?
Our foundation investing course article on how to build an investment portfolio explains that you should diversify your investments in any asset classes. One way to do this is to spread your equity investments across many different countries.
This will allow you to invest in the stock markets of economies which have higher economic growth than your own. The stock market returns of such economies are not guaranteed to provide a higher return, but they have historically been the source of much growth in worldwide stock market indices over the last two decades.