Factors Affecting Economic Growth
Foreign exchange dealer at HFC Bank
Since the COVID-19 pandemic began in March 2020, the world economy has been affected in many ways.
Developing countries have suffered the most, but despite their greater resources, wealthier countries have faced their own challenges.
In some countries, COVID-19 infection rates have fallen significantly. But whether governments are actively managing outbreaks or returning to normalcy, economic recovery is central to their forwardlooking agenda.
In the midst of a global pandemic and the discussions on its relative impact on the economies, it is noteworthy to mention some of the key drivers of economic growth or decay otherwise.
Economic growth is an in real Gross Domestic
(GDP).
It represents the total dollar value of goods and services produced in an economy over a specific time adjusted for any price movements. increase Product
The rate of economic growth is the annual percentage increase in real GDP and is expressed as a comparison to the previous quarter or year. For example, if the year-toyear GDP is up 2 per cent, this is supposed to mean that the economy has grown by 2 per cent over the last year.
While there are several factors affecting economic growth, it is convenient to split them up into two broad categories:
Demand side factors consumer spending) Supply side factors productive capacity)
In the expenditure approach to calculating GDP, the demand side factors are captured by Aggregate Demand and is composed of Consumption, Investment, Government spending and Exports. A rise in Consumption, Investment, Government spending or Exports can lead to higher Aggregate Demand and hence higher economic growth.
What factors demand? Interest rates. influence (e.g. (e.g. aggregate
Interest rates are the cost of borrowing or the reward for saving money. It affects peoples’ decisions on whether to save or spend their money. Usually if the interest rate is high, people tend to delay their consumption and save more to earn a higher return. Similarly, high interest rates often lead to reduced borrowing as the cost of borrowing increases. In times of lower interest rates, there is more borrowing as the cost of borrowing would be reduced and less saving due to less return. This increased borrowing and reduced savings would result in increased spending and hence boosts economic activity. The decisions by savers and borrowers affect consumption and investment decisions, and ultimately aggregate demand and overall economic activity.
Value of exchange
The exchange rates have a direct relation to the nation’s trade deficit. While many of us may disdain a weaker domestic currency because it makes cross-border shopping and overseas travel more expensive, a weaker currency would normally stimulate exports and discourage imports, thereby decreasing a nation’s trade deficit (or increasing surplus) over time. Of the many other factors, a stable exchange rate system also attracts foreign investments which provides essential ingredients that are necessary for economic growth.
Consumer confidence reflects the consumers’ perception about the overall state of the economy and their expectations for future. It determines the willingness of consumers to spend, borrow and save and is used as an indicator of the overall state of the economy. A strong consumer confidence indicates a rise in consumer spending and hence increase in economic activities.
Real balance/ income reflects the purchasing power of a given amount of money in circulation. Real income is affected by the price levels (inflation). When prices fall, the purchasing power of the currency goes up and people can purchase more goods and services from their same level of income which in turn impacts the level of aggregate demand and consequently the level of economic activity.
In the long run, the increase in aggregate demand alone will be seen as inflationary unless there is in
CONsuMEr CONfiDENCE. Real balances. rate.
crease in aggregate supply. Therefore, the long run aggregate supply should increase with the rise in aggregate demand leading to an increase in economic growth without inflation.
The supply side of the economy reflects the willingness and ability of producers to supply GDP.
Key factors that influence country’s supply-side potential:
Increased labour market participation and improvements in productivity and efficiency of the labour force directly impacts the production capacity of the economy. This in part is affected by improved work incentives, investment in capacity building of the labour market through better education and training and through improved mobility of the labour force. Increased strength of the labour market results in increase in output and so impacts the growth potential of an economy.
Human Development ogy.
Technological advancement has been one of the key reasons, if not THE key reason, that the modern economy has achieved current, historically unprecedented, living standards. Technological advancements allow suppliers to produce more goods at cheaper cost. This leads to increase in production capacity and hence increase in aggregate supply.
Levels capital. of of a technolinfrastructure.
Investment in roads, transport networks and communication can help firms reduce costs and increases the potential output of an economy. Infrastructure development is considered as a complementary factor for economic growth.
There are other factors also that affect the growth potential economy in the short term.
Some of these are changing climate situation, commodity prices, political stability, and government policies.
However, the COVID-19 pandemic had dominated all other risks to domestic growth and now tops the list in every geography.
In the COVID-19 pandemic situation, the primary risk is considered to be contracting the virus, while the economic impacts caused by the mitigating measures such as unemployment, income loss etc, is regarded as a secondary risk, which are generally tolerated in order to address the primary risk. This challenge can be viewed as a risk–risk trade-off.
Government spending is another important factor that gained prominence in the past two years.
When Government spending is zero, presumably there will be very little economic growth because enforcing contracts, protecting property, and developing an infrastructure would be very difficult if there were no government at all.
In other words, some government spending is necessary for the successful operation of the rule of law. Economic activity is very low or non-existent in the absence of government, but it jumps dramatically as core functions of Government are financed.
This does not mean that government costs nothing, but that the benefits outweigh the costs.
Policy makers and governments’ world over are being faced with similar dire situation of recovering their economy from what the pandemic has left behind.
Although this warrants a comprehensive action plan and rapid rollout measures, the need to quickly recover economically is typically an immediate priority to any nation. of an