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What Is Economic Growth?


What Is Economic Growth?

Homebuilding is usually a sign of economic growth. (Photo: Justin Sullivan/Getty Images)

Question: What Is Economic Growth?
Answer: Economic growth is the most watched economic indicator. It tells you how much more the economy is producing than it did before. If the economy is producing more, businesses are more profitable, and stock prices rise. This gives companies capital to invest and hire more employees. As more jobs are created, incomes rise. This gives consumers more money to buy more products and services, driving more economic growth. For this reason, all countries want positive economic growth.

How Is Economic Growth Measured?

Economic growth is measured by changes in the gross domestic product, or GDP. This measures a country's entire economic output for the past year. This takes into account all goods and services that are produced in this country for sale, whether they are sold domestically or sold overseas. It only measures final production, so that the parts manufactured to make a product are not counted. Exports are counted, because they are produced in this country. Imports are subtracted from economic growth.

Measurements of economic growth do not include unpaid services, such as the care of one's own children, unpaid volunteer work for charities, or illegal or black-market activities. Because these are not measured as part of economic growth, their impacts on the well-being of a society are not taken into account.

Economic growth is measured by real GDP. This is done to compensate for the effects of inflation.

The Phases of Economic Growth

Economic growth is watched to find out what stage of the business cycle the economy is in. The most desirable phase is expansion, when the economy is growing sustainably. If growth is too far beyond a health growth rate, however, then it can overheat and create an asset bubble. This is what happened in 2005-2006 with housing. As too much money chases too few goods and services, inflation kicks in. This is usually the "peak" phase in the business cycle.

At some point, confidence in economic growth dissipates. When more people sell than buy, the economy enters the contraction phase of the business cycle. When economic growth becomes economic contraction, it's known as a recession. An economic depression is a recession that lasts for a decade. The only time this happened was during the Great Depression of 1929.

What Are the Drivers of U.S. Economic Growth?

The U.S. has been blessed by an abundance of natural resources in a large land mass, comparable only to Russia, Canada and Australia. These resources include:
  • tillable soil in the Great Plains, known as the breadbasket of the world,
  • a temperate climate,
  • large deposits of oil, coal and natural gas.
These natural resources attracted another of America's great resources -- its people. Since the U.S. has a lot of people within its borders, domestic companies have become very good at knowing what consumers want. This has given the U.S. a comparative advantage in producing consumer products. As a result, over 70% of what the U.S. produces is for personal consumption.

This gives the U.S. economy an advantage in exporting, making the U.S. the world's fourth largest exporter. The U.S. exports capital equipment, such as computers, semiconductors and medical equipment, as well as industrial machinery and equipment, such as plastics, chemicals and petroleum products. Nearly half of the strength of the economy is based on services, such as financial services, health care and intellectual property, such as technical information.

Ways to Spur Economic Growth

Most governments try to manage economic growth. For one thing, when the economy is growing, businesses make more money, which increases tax revenue. They also hire more people, which increases income. When people feel prosperous, they reward political leaders by re-electing them.

The government can stimulate the economy through expansive fiscal policy, which is spending on government programs or tax breaks. Since politicians want to get re-elected, they use expansive fiscal policy to stimulate the economy.

Expansive fiscal policy is addictive. If the government keeps spending more and taxing less to spur economic growth, it leads to deficit spending. This works for a while, but eventually leads to higher debt levels. In time, as the debt to GDP ratio approaches 100%, it can slow economic growth. Foreign investors may stop investing funds in a country with a high debt ratio, because they are worried they won't get repaid, or that the money will be worth less. Therefore, governments should be careful with expansive fiscal policy. It should only use it when the economy is in contraction or recession. When the economy is growing, its leaders should cut back spending and raise taxes. This conservative fiscal policy will ensure that the economic growth will remain healthy. (Article updated April 18, 2012)

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