1997-1998 Essay Contest - Why do some countries grow faster than others? What, if anything, can a central bank do to enhance economic growth?
Eager buyers crowding checkout lanes, cranes erecting buildings or help-wanted signs filling store windows—all are signs of economic growth, which largely affects the material well-being of a country. When the economy expands, jobs are created and goods and services to meet people's needs increase. For these reasons, economists are interested in the causes of growth and what countries can do to maintain or enhance it.
Throughout history, some economies have expanded faster than others. Some differences can be traced to such inherent factors as climate and geography. At times people living near navigation routes or in temperate climates have fared better than people living far away from coastlines or in frigid climates. Some analysts also argue that culture plays a role in growth.
While inherent traits are responsible for some differences in economic growth, government and central bank policies also play a role. Policies affecting access to technology, sound money and banking practices, and prudent taxing and spending can improve or stifle economic growth.
Participants of this year's essay contest are asked to argue which factor(s), including the role of a central bank, have the most influence on economic growth. By comparing economic data among countries and understanding the contribution of the various factors of economic growth, participants will respond to the following questions:
Why do some countries grow faster than others? What, if anything, can a central bank do to enhance economic growth?
What is economic growth?
Economic growth is reflected by an overall improvement in the quality of life in a given country. This may include better health care, a cleaner environment and more freedom in terms of choosing work and leisure activities. During times of economic growth, the overall wealth of a country increases, as do the variety and abundance of goods and services.
Economic growth is not easy to measure. When the Federal Reserve gauges the level of economic growth in the United States, it considers many forms of data and comments from businesses and consumers. A widely used proxy for economic growth is changes in real gross domestic product (GDP) per capita—the final sales of goods and services in a country per person, adjusted for inflation. Economists track real GDP per capita over time to compare growth among countries and the effects of various factors of economic growth. Below is a chart that shows real GDP per capita in Japan, Mexico and the United States from 1970 to 1992.
Factors of economic growth
Economists continue to seek to understand the forces underlying economic growth. While they don't agree on which factors are the most significant, they have compiled a long and varied list. There may not be a definitive answer to the question: Why do some countries grow faster than others? However, it is possible to argue how particular factors contribute to growth and explain why some are more significant than others. Below are the categories most economists agree influence economic growth.
In most countries government has a significant influence on economic performance, especially due to its size. In the United States, government spending accounts for one-fifth of GDP. The taxing and spending policies of the government affect the incentives to spend and invest.
Some economists argue that the government may affect the overall performance of the economy. Regulations, taxes and government spending can vitalize or stifle economic activity in various sectors of the economy. On one hand, if the government spends more than it collects in tax revenues, deficits can slow the economy. On the other hand, a well-planned road system can increase market efficiency and help improve the economy.
The government plays a role in the economy by correcting for market failures and protecting property rights. Market failures happen when the market has an effect outside the buyers and sellers. For example, companies that emit pollutants into the air may cause health risks for other people. In response, the government might regulate how much pollutants a company can release. Schools and other basic infrastructure, such as roads and bridges, benefit almost everyone. However, the market may not produce schools and roads since the costs and benefits of such projects are shared across a large number of people. In these cases, the government steps in to provide these needs.
Property rights provide the rules of ownership and trade so consumers and businesses know what they can and can't do in the marketplace. For example, consumers are protected from misleading information by consumer protection laws and inventors are protected by patents and copyright laws. Without well-defined property rights, the players in the market can't depend on particular outcomes important for making purchasing or investment plans. Countries with relatively well-organized and consistent legal systems will tend to have more efficient markets than countries with loose and inconsistent legal systems.
International trade and finance
Just as individuals specialize in an occupation they do best, countries specialize in producing particular goods and services depending on their natural resources and education of their labor force. Countries with large areas of nutritious soil might specialize in agriculture, whereas a country with a labor force trained in electronics might specialize in producing computer chips. Countries can specialize in the goods and services they produce best and trade for the goods and services they produce relatively less efficiently. The more countries can specialize and trade, the more economic growth they will realize in the long run. If trade is slowed, countries will have to produce goods and services that they produce less efficiently instead of trading for them.
Trade policy, such as quotas and tariffs, directly affects trade flows. Also, exchange rates among countries can affect trade as the cost of goods and services from other countries fluctuates with movements in exchange rates. Some economists consider these factors pivotal in terms of economic growth. For example, if the United States places a tariff on imported automobiles, the price of cars in the United States will likely increase.
Technology and investment
Technology refers to advancement in knowledge and how it's employed in the productive process. For example, the micro-chip processor helped businesses incorporate computer systems into the production process and sales. Countries that have a wealth of research and development and/or access to new technology often have a more productive work force than countries without access to technology. As productivity increases, economic growth increases. Investment in new technology or buildings can lay the groundwork for growth in years to come. Countries with institutions that facilitate the appropriation of technology and accommodate investment will realize increases in total output.
Political, social and geographical conditions
Countries with challenging terrain or weather may need to find creative ways to adapt to their surroundings. The political and social climate of a country influences the total output of a country's economy. Crime, poverty, income disparity and armed conflicts can be a cause, or a result, of low economic growth. Nevertheless, social problems can develop despite high economic growth. The culture of a country can have an effect on what and how goods and services are produced. Cultural tendencies can create biases for and against various market mechanisms and may influence the pace of production. The location and climate of a country can also contribute to economic success or difficulty.
Money and banking
A central bank, such as the Federal Reserve in the United States or the Bundesbank in Germany, is responsible for regulating the amount of money in circulation. Too much money in circulation can drive prices up, causing inflation. Too little money can pull prices down, which can depress economic activity. Finding the right balance is a central bank's primary responsibility. This places a central bank in a position to facilitate economic growth by stabilizing overall prices.
Some central banks act as a regulator of banks and provide oversight for the payments system, which includes cash, checks and electronic payments. At the turn of the century in the United States, widespread bank failures caused panic among depositors throughout the economy. Today, bank examiners of the Fed and other government agencies help locate small problems in banks before they become bigger. In its role as overseer of the payments system, the Fed helps keep the gears of the economy well greased, allowing for the easy flow of goods and services.
Comparing factors of economic growth
With these and other factors of economic growth in mind, what makes one factor more significant than another? A few things to consider:
- What relationship does the factor have with the whole economy? How does the factor contribute to economic growth?
- What would the economy be like if there were significant problems with this factor?
- Is the factor a cause or effect of economic growth?
- What relation does a central bank have to this factor?
Collecting data on economic growth
Comparing economic data of different countries can be helpful when looking at which factors of economic growth are significant in terms of enhancing economic growth. Many libraries have publications from the World Bank that provide economic and population data on countries. The Internet also has data resources available. One such resource is the Penn World Tables. By selecting a country and subject code, you can find economic data on almost every country in the world. It may be helpful to compare data between countries that have a slow-growing or even a decreasing GDP versus countries with a fast-growing GDP.
From money and banking to taxing and spending, many factors influence economic growth. Now it's your turn to use resources available on the Internet, in libraries and your school and community to research and write this year's essay. Join the ranks of economists around the world who are interested in what makes countries grow.