Impact of Growth
Definition
Economic growth: a sustained rise in real GDP, the total real output of an economy, over time.
Negative externality: a cost of production or consumption that falls on third parties not involved in the activity, such as pollution or congestion.
- Growth raises average incomes, but its benefits and costs are spread unevenly across consumers, firms, the government and living standards.
Consumers and Firms
- For consumers, growth raises employment and real incomes and widens the choice of goods and services, so material living standards rise.
- The gain is not guaranteed, because fast growth near full capacity can add to inflation that erodes the purchasing power of those wages.
- For firms, higher demand raises sales, profits and confidence, which encourages further investment; this extra investment can then raise productivity and reinforce growth.
Example
- As the UK economy expands, a household may gain from a pay rise and a wider range of goods, though rising prices offset part of the gain.
- Confident supermarkets and manufacturers invest in new stores and machinery when they expect demand to keep rising.
Government and Living Standards
Definition
Fiscal (budget) deficit: the amount by which government spending exceeds tax revenue in a single year; it is a flow.
National debt: the accumulated stock of past government borrowing that has not yet been repaid.
- For the government, growth automatically raises tax revenue (income tax, VAT and corporation tax) and cuts spending on unemployment benefits, so the fiscal deficit shrinks.
- A stronger fiscal position lets it fund public services without raising tax rates, though the national debt built up in the past may still be large.
- What matters for sustainability is the debt-to-GDP ratio: if real GDP grows faster than the debt, the ratio can fall even while the cash value of the national debt still rises.
- For living standards, higher real incomes can improve health, education and housing; even a steady 2%2\%2% a year roughly doubles real income in about 35 years.
- There is a trade-off over time, because investing for future growth means diverting resources away from consumption today, lowering present living standards to raise future ones.
Example
- The Office for Budget Responsibility (OBR) forecasts the UK public finances, and the fiscal rules require public sector net debt to be falling as a share of GDP.
- After the deficit peaked following the 2008-09 crisis, the recovery in growth through the 2010s lifted tax revenue and helped the annual deficit fall back towards more sustainable levels.
Costs and Sustainability
- Growth carries costs, above all the negative externalities of pollution and congestion that accompany more production and transport.
- It can deplete finite resources and widen inequality if the gains flow mainly to higher earners, so whether growth is desirable depends on how sustainable it is and how fairly its gains are shared.
Do the benefits of growth outweigh the costs?
- It holds because higher real incomes, more jobs, stronger profits and healthier public finances lift material living standards across the economy.
- But rapid growth can bring pollution, congestion, resource depletion and wider inequality, and it may add to inflation that erodes the real value of the extra income.
- On balance it depends on the type of growth: sustainable, investment-led growth whose gains are widely shared is beneficial, whereas unsustainable growth that damages the environment or bypasses low earners may not be.
Exam technique
- Judge the impact separately for consumers, firms, the government and living standards.
- Set the gains against costs such as pollution, resource depletion and inequality.
- Bring in the trade-off between present and future consumption to reach a judgement.
Common Mistake
- Do not treat growth as purely good; it can bring pollution, resource depletion and wider inequality alongside its gains.
- Do not confuse the fiscal deficit (a yearly flow) with the national debt (the accumulated stock).
Self review
- Give two benefits and two costs of economic growth.
- How does growth affect consumers?
- How does growth affect firms?
- How does growth affect the government's finances?
- What is the trade-off between current and future living standards?
