Economic growth is an increase in production capacity of a given country. This can also be defined as the rise in market value of commodities produced by a certain economy over a given period. This is measured through a detailed comparison between the Gross Domestic Product (GDP) of the current year with that of the previous year, and is usually expressed in percentage form (Valdes, 1999). An increase in gross domestic product as a ratio of the population, which is known as per capita income, is a clear show of economic growth of a given country.
Gross domestic product (GDP) is the cumulative measure of a country`s production. This is computed through summing the gross values added of all the people in that country, with units involved in production of various institutions. Taxes are added if any and subsidies subtracted on commodities that are not included in the value of their produce. These GDP estimations are the one used to determine the economic progress of a country. The GDP increase because of efficient application and use of inputs is known as intensive growth, whereas, GDP growth, which is only because of increase in inputs such as population and capital, is known as extensive growth. The GDP patterns, as observed yearly determine the success or failure of the economic policies applied in a given country (Hess, 2013).
Economic growth is an important aspect of economic development in a country (Amartya k. 1973). These two aspects do differ although looking like the same thing. Economic development is a policy that is aimed at social and economic well-being of people in a given country. For a country to be economically developed it has to be associated with an increment in per capita income which is an aspect which also increases economic growth (Van Den Berg, 2012). Therefore, an increase in economic growth of a country has a positive impact on the economic development of that nation.
Measurement of economic growth
As earlier mentioned, growth is measured as a percentage increase in gross development product, and has to be in real terms. In other words, the measurement should be carried out in inflation-adjusted terms so that to do away with the change effect on inflation and on the price of produced commodities (Durlauf and Blame, 2010). Most countries have a very small rate in the increase of economic growth yearly. However, how small these rates may be, they have huge effects on the people of that nation over a long period of time. These small growth rates between countries can increase the standards of living of the citizens over a long period of time.
Importance of Economic Growth
Economic growth is a key promoter of improved living standards among the residents of a given country. In an economy, where the output grows faster as compared to the population, GDP per capita, it’s likely to be associated with a rise in the average living standards of the people (Valde, 1999). The level of a country`s productivity is termed to be the most important determinant of the standards of living, whereby, faster productivity growth results to a better people`s standards of living.
If economic growth is correctly maintained, it is likely to increase resources for crucial public services for example infrastructure, health, and education. It will enable the residents to increase social spending without the rise of taxes (Lagrandville, 2011). This is a clear indication of a nation with better standards of living. One of the methods of measuring a country`s living standards. Considering the developing countries, an increase in per capita income among families, results to a reduction in absolute poverty in that nation. This would have a general increase in the living standards of the residents of that country.
Economic growth addresses the social and economic problem of unemployment in different countries. Unemployment is believed to be the major causes of poverty and social imbalances among most developing states. A nation, which experiences economic growth, increases its investments and more complex procedures are added to its industrial production structures. These industries will most definitely increase the number of workers in those extended structures thereby creating more jobs (Lagrandville, 2011). Therefore, through creation of jobs, economic growth could have contributed to reduction of unemployment.
A nation with high economic growth rates is likely to lower government borrowings from the World Bank, other developed countries, or lending bodies. Economic growth raises tax revenues not through increase of tax rates but rather high spending abilities by the public. In addition, the government minimizes expenses on benefits such as creation of job opportunities. Therefore, the government will be able to make and save money, which can be allocated for various projects. Economic growth further plays a key role in decreasing debt to gross domestic product ratios, which is the ratio of the government`s debt to gross domestic product. A low ratio means that the economy is able to produce and market goods and services enough to settle debts without further borrowing (Hess, 2013).
A well performing economy with average economic growth rates will facilitate environmentally friendly practices in a country promoting environmental conservation. In a progressive economy, there will be availability of more resources, which can be used to invest in cleaner technologies, which are more environmental friendly. Also a society with a higher real GDP can be able to allocate more resources in environmentally friendly acts like the application of renewable resources and recycling (Hess, 2013).
Economic policy tools to encourage economic growth
Economic policies are the steps that governments take in controlling economic issues. These steps includes, setting rates of taxation, labor markets, interest rates, government budgets and many others. Economic policies can be divided into two, namely fiscal policy, which involvesgovernment actions concerningspending, taxation, and monetary policy, which deal with management of interest rates and money supply by central banks (Glyfason, 1999).
The goals of economic policies include; attaining economic growth, creating full employment, and stabilizing prices (Hou, 2013). A country with a flourishing economy has a better GNP growth rate, which is facilitating the growth. The governments too are aiming at attaining stable interest rates, well balanced budget without deficits and trade equilibrium with other countries. In order for the government to achieve these objectives it applies economic policy tools. These are the aspects on which changes are to be made in order to achieve the objectives of economic policies. They include exchange rates, tariffs, labor markets, taxes, money supply, and others within governmental control.
Monetary policy tools
Open market operations
Open market operations refer to an act of the Central Bank on selling or purchasing government bonds on open markets. The government uses open market operations to control the economy (Berkmen, 2007). This is achieved through ensuring that the base money is per its demand at a given targeted interest rate, which is attained by the selling and buying of the government securities. Therefore, the government through the Central Bank should enforce the expansionary policy in order to affect economic growth positively. The Central Bank can decide to buy government bonds to decrease the rates of bonds. This will increase the money supply and as well decrease interest rates thereby increasing consumer spending and also widening investments (Hou, 2013). However, increasing money supply in an economy is tricky to the extent that it may bring about inflation. Therefore, the government should first have a detailed study of the economy before applying this policy tool.
Interest rate controls
These are the interest rates on loans that financial institutions take from the Central Banks. The Federal Bank has the powers to either increase or decrease for the safety of the economy. The Central Bank can take the option of cutting down interest rates. Lowering the interest rates will decrease the costs of borrowing money from financial institutions (The Federal Reserve Bank of Dallas, 2002).Many people and firms will be willing to borrow money from financial institutions to carry out various investment projects. Therefore, this will speed up development through increased investment projects, which will ultimately lead to creation of employment in the designated investment sites.
In addition, lower interest rates will reduce the morale to save among the public, and this will boost consumer spending. Increased consumer spending will raise the aggregate demand of the economy (Eicher and Garcia, 2006). Due to the rise in demand, production will broaden hence increasing the GDP of the country. The lower rates will also decrease mortgage interests thereby increasing the amount of income to spend for consumers. The final effect will be creation of jobs and most definitely accelerated economic growth. However, in a situation where there is a liquidity trap, the option of lowering the rates may not have an effect on spending; the public will be committed in paying back their debts. Therefore, the government should also analyze the economy in a detailed form before using this tool.
Bank reserves are the amount of funds that banks and other financial institutions put aside in form of a reserve in the accounts they hold in Central Banks to cater for any unexpected outflow. The Central Bank can opt to reduce the amount of money that financial institutions hold as reserves. This will increase liquidity and promote money lending in the banks (Ueda, 2006). Therefore, people will be encouraged to process loans, which they will access with reduced interest rates and use them for various developments. This will accelerate economic growth in that economy because there will be increased consumer spending and the GDP will be increased.
The Central Bank has powers to set the credit limit that is acceptable for every financial institution. This aids the government in controlling the money supply in the economy. The Central Bank can increase money supply by increasing the threshold to which it lends money to financial institutions. Similarly, it can reduce the credit limit to decrease money supply in the economy. It is upon the government to use the right option at a particular time for effective progress and growth of the economy. Mostly the economic growth is accelerated through increase of money supply; therefore, the government should increase the limit of lending money to financial institutions. People will be able to access loans easily because the banks will be having enough finances. Through credit control, inflationary trends can be controlled as well as acceleration of economic growth, which will definitely raise national income and the economy`s stability. Increased national income raises consumer spending and the cycle takes its course.
Fiscal Policy Tools
Taxes are financial levies that are imposed on a taxpayer by the government through authorized bodies. They form a state`s major source of revenues. The government can use tax rates to impact the economy positively. Engen and Skinner (1996) argue that A reduction in tax rates can increase demand in the economy. The government should decrease income tax, a change, which is believed to motivate workers and affect labor supply positively. There will be a rise in the amount of disposable income among the country`s citizens. This change will boost consumer spending, and the aggregate demand too will rise. Similarly, the gross demand product will increase a clear indicator of a well progressing economy. Usually taxes reduce the public`s disposable income because it doesn`t get a channel to flow into consumption (Buti, 2003).
This is abroad area, which includes government investment, transfer payments, and government consumption. As noted by Cashin (1994), Government spending is considered an economic policy tool due to its tendency to increase or decrease the gross domestic product. An increase in the spending of the government raises both the aggregate demand and consumption which accelerates the production process. Therefore, the government should rise its spending to contribute to economic growth. For example if a government orders some goods from a seller in large quantities, production of those goods will be forced to speed up so as to keep the right stock in the market. This will require employment of more employees, who later will be paid and spend on goods and services. Therefore, the government through a single expenditure will be able to create employment and increase production indirectly which will speedup the economic growth of the country. However, increased government spending will lead to a decrease in the demand of money speculatively. The government first should study the economy well before taking this option.
The government should create flexible labor markets, which will attract investors. Excessive regulatory laws on labor markets are likely to discourage potential investors from setting up and employing workers. Labor markets, which are flexible, can be able to bring about a long-term positive impact on investment. Tarling (1987) argues that inflexible labor markets are likely to make full time employee inessential and probably their spending will reduce. Therefore, the government should always adopt a flexible labor market with exchange programs between full-time workers and part-time workers.
This is a non-exhaustive redistribution of income within the market operations without involving exchange commodities. Examples of these transfer payments are; social security, subsidies from the government, and social welfare. These payments are received by the public throughout the country and acts as consumer`s income. Transfer payments have more similar effects to the economy as tax does. This is because an increase or decrease in these payments will bring changes in their income.
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