Why economies grow

It feeds in to other spheres of life, too: experts in many fields, from healthcare to climate change, need to make assumptions about future economic growth. Every three months we forecast economic growth up to three years ahead. Our forecasts are published in our Inflation Report and feed into our decisions about interest rates. View more You may also be interested in…. Would you like to give more detail?

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Skip to main content. Home KnowledgeBank Why does economic growth matter? Why does economic growth matter? Find out what it means when people talk about economic growth. Economic growth — fast, slow, or negative — is in the news a lot. But what is it? What is economic growth? Play Why does economic growth matter?

When you hear about economic growth in the news, people often refer to this thing called GDP. This would include many of the goods and services on that long list we considered earlier, but would exclude your breathing, for example.

Because economic goods are scarce in relation to the demand for them, human effort is required to produce them. The majority of goods and services on that long list above are uncontroversially of the economic type — everything from the light bulbs and furniture in your home to the roads and bridges that connect it with the rest of the world. They are scarce in relation to the demand for them and have to be produced by someone, their production is delegable, and they are considered useful by those who want them.

Imagine two countries that are identical except for one aspect, home ownership. In Country B everyone owns their own home and no one pays rent. To avoid such misjudgment, the production boundary includes the housing services that are provided without any monetary transactions.

GDP does not only include the housing services by owner-occupied housing, but also the provision of most goods and services that are provided by the government or nonprofit institutions.

Many discussions about economic growth are extraordinarily confused. People often talk past one another. I believe the reason for this is that the discussion of what economic growth is , gets muddled up with how it is measured. While it is straightforward enough to define what growth is, measuring growth is very, very difficult.

In the worst cases measures of growth are mixed up with a definition of growth. Growth is often measured as an increase in income or inflation-adjusted GDP per capita. But these measures are not the definition of it — just like life expectancy is a measure of population health, but is certainly not the definition of population health. To see how difficult it is to measure growth, take a moment to think about how you would measure it. How would you determine whether the quantity and quality of all economic goods and services produced by a society increased or decreased over time?

Finding a measure means that you have to find a way to express a huge amount of relevant information in a single metric. As the sketch shows, you have to first measure the quantity and quality of all the many, many goods and services that get produced and then find a way to aggregate all of these measurements into one summarizing metric.

No matter what measure you propose for such a difficult task, there will always be problems and shortcomings of any proposal you might make. In the following section I will show four possible ways of measuring growth and present some data for each of them to see how they can inform us about the history of material living conditions.

One possible way to measure growth is to make a list of some specific products that people want and to see what share of the population has access to them. We do this very often at Our World in Data. The chart here shows the share of the world population that has access to four basic resources.

All of these statistics measure some particular aspect of economic growth. You will find that judged by this metric some countries achieved rapid growth — like Indonesia — while others only saw very little growth, like Chad.

The advantage of measuring growth in this way is that it is concrete. The downside is that it only captures a small part of economic growth. There are many other goods and services that people want in addition to water, electricity, sanitation and cooking technology.

You could of course expand this approach of measuring growth to many more goods and services, but this is usually not done for both practical and ethical considerations. One practical reason is that a list of all the products that people value would be extremely long. In practice any attempt to measure growth as access to particular products therefore means that you look only at a relatively small number of very particular goods and services that statisticians or economists are interested in.

This is problematic for ethical reasons. It should not be up to the statisticians or economists to determine which few products should be considered valuable. You might have realized this problem already when you read my list at the beginning of this text.

You might have disagreed with the things that I put on that list and thought that some other goods and services are missing. On our site you find many more such metrics of growth that capture whether people have access to particular goods and services:. We have to look at the ratio between income and prices. The chart here does this for one particular product — books — and brings us back to the history of growth in the publishing sector that we started with.

It shows how long the average worker had to work to buy one book. Note that this data is plotted on a logarithmic axis. Before the invention of the printing press in the 15th century the price was often as high as several months of work. The fact that books were unaffordable for almost everyone should not be surprising. The chart also shows how this changed when the printing press increased the productivity of publishing. As the labor required to produce a book declined from many months of work to less than a day, the price fell from months of wages to mere hours.

This shows us how an innovation in technology raises productivity and how an increase in production makes it more affordable. How it increases the options that people have. In the previous section we measured growth as the ratio between income and the price for one particular good.

But of course we could do the same for all the many goods and services that people want. A means to many ends in fact. It is because a person has more choices as their income grows that economists care so much about these monetary measures of prosperity. They are shown in this chart. Both measures show that global inequality is very large. An income of int. If you are living in a rich country and you want to have a sense for what it means to live in a poor country — where incomes are times lower — you can imagine that the prices for everything around you suddenly increase fold.

Savings and investment increase when present consumption is delayed for future consumption. The financial sector banking and interest provides this function in modern economies. The other way to improve productivity is through specialization. Laborers improve the productivity of their skills and capital goods through education, training, practice, and new techniques. When the human mind better understands how to use human tools, more goods and services are produced and the economy grows.

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Your Money. Personal Finance. Your Practice. Popular Courses. Economy Economics. Compare Accounts. Workers have gotten more productive over the past few decades, after all, so if GDP growth were to be less of a priority, a society could use the benefits of technological production to reduce working hours, all while producing the same amount.

A new economy could also focus more on the health of the environment. While the government has put in place polices that express other values, such as environmental protection—those policies are often said to be directly at odds with economic growth, instead of seen as being in concert with a suite of goals that involve trade-offs.

After all, growth depends on countries producing more and more goods, often using natural resources to do so. Economists often say that without growth it will be impossible to address income inequality. The more economic activity being created, they say, the more room people have to move up the economic ladder and perform to their full potential.

And proposals for addressing inequality, such as raising taxes on the rich, are often nixed because some economists say such prescriptions might reduce economic growth.

That might mean raising taxes on the rich, or increasing tax credits for the working poor or middle class. Redistribution could be achieved by providing better educational or job opportunities for the disadvantaged, without worrying about the downsides of such government spending. It could also mean providing a basic income for the poor, something the Dutch city of Utrecht is about to test. Without growth, said Gordon, the Northwestern economist, if the country wanted to add those programs within its existing budget, it would have to cut something else or raise taxes.

This goes for paying Social Security and Medicare, too, which are funded through taxes.