The costs and benefits of economic growth

“Ultimately long-run growth is the most important aspect of how the economy performs. Material standards of living and levels of economic productivity in the United States today are about four times what they are today in, say, Mexico-and five or so times what they were at the end of the nineteenth century-because of rapid, sustained long-run economic growth. Good and bad policies can accelerate or cripple this growth. Argentines were richer than Swedes before World War I, but Swedes today have four times the standard of living and the productivity level of Argentines.

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Almost all of this difference is due to differences in growth policies working through two channels. The first is the impact of policies on the economy’s technology that multiplies the efficiency of labour. The second is their impact on the economy’s capital intensity-the stock of machines, equipment, and buildings. ” The Economist (July 2002) “Flying Blind – Growth and the Environment” “WHAT is the true state of the planet? It depends from which side you are peering at it. Things are really looking up,” comes the cry from one corner (usually overflowing with economists and technologists), pointing to a set of rosy statistics. “Disaster is nigh,” shouts the other corner (usually full of ecologists and environmental lobbyists), holding up arrival set of troubling indicators” What are the main benefits of economic growth? Employment Economic growth is a key factor in increasing employment levels. The result of this is likely to be a rise in disposable income and hence an increase in the real purchasing power of consumers.

With a rise in real national output comes a rise in living standards and the opportunity to reduce absolute poverty. Although relative poverty can increase in a period of economic growth it is likely that absolute poverty will fall and a progressive tax system could be developed to narrow the divide between rich and poor. In this sense economic growth is essential for low-income countries where a substantial proportion of the population is blighted by absolute poverty. The key is whether the gains from a growing economy filter through to a sufficiently large percentage of the population

The fiscal dividend from economic growth With economic growth comes a fiscal dividend. Unemployment is likely to decline, although as Okun’s law says only if productivity is growing at a slower rate than the economy, and hence unemployment benefit and other welfare state payments linked to household income will fall. At the same time if people are earning more and businesses are enjoying higher profits then they are going to pay more in direct tax such as income tax and corporation tax.

This effect is greater than might be imagined as in a period of rapid growth the number of people paying the higher tax rate increases, in other words, the tax base of the economy expands. The government could chose to allocate some of the extra tax revenue to conserving the environment and hence minimise some of the environmental externalities that are associated with economic growth or it could increase spending on public and merit goods which might provide an improvement in a country’s social welfare.

It is also easier to achieve a redistribution of income and wealth when the economy as a whole is growing – because the size of the “national cake” is expanding. Growth and investment Much capital investment is income or demand induced – so that when demand is running strongly, many businesses will be looking to go ahead with planned capital investment projects designed to boost their productive capacity, exploit potential economies of scale and raise productivity.

Higher investment adds to aggregate demand in the short term but also provides a platform for a higher underlying rate of growth in the long run because of the potential for increasing returns to scale, a faster pace of innovation and invention and an improvement in a countries’ international competitiveness. Is Economic Growth Sustainable? Environmental pessimism: resource depletion and the declining environmental quality of planet earth Some people argue that economic growth is not sustainable in the long run.

Oil is a finite resource that is being used up at a rapid rate. Is it realistic to believe that if the world economy continues to grow and the dependency on oil increases that there will be any oil in a hundred years? If this is true are we therefore reducing future generation’s standards of living by consuming an unfair share of finite resources today. If we undervalue the environment and in particular the finite resources at our disposable we risk causing permanent damage to our natural resource base which will place a severe constraint on growth in the future.

This includes the destruction of the rainforests for raw materials and the increased burning of fossil fuels in order to generate further output The Mother of Invention An opposite view is that ‘necessity is the mother of invention’. For example when crude oil becomes scarce market forces will lead to an increase in the price and that other fuels, which are at present not economical, will become viable and hence will be developed to become efficient. Brazil tried to introduce cars that were run on ethanol in the eighties as a response to high oil prices.

These were a success until falling oil prices meant that the less efficient ethanol engines gradually died out. Had oil prices remained high the engines would have been improved as new technology was developed. This is evidence that we can adapt. Professor Julian Simon argues that “One of the greatest trends of the past 100 years has been the astonishing rate of progress in reducing almost every form of pollution. ” Environmentalists would argue that it is not only that scarce resources are being used up but also that they are damaging the environment.

New factories produce more greenhouse gases, toxic gasses, noise and visual pollution. While it is true that new factories do, of course, pollute, in Britain the manufacturing sector continues to decline as a percentage share of real national output and it is services that are now the driving force behind economic growth. Service sector industries pollute but the long run transition from heavy industries might actually be beneficial to the environment.

One criticism of this argument is that although an economy may change structurally in favour of a service-based economy it is unlikely that the demand for manufactured goods will fall. The result of this is that the developed economy imports the goods that it used to produce and that the ‘heavy industries’ are still polluting but elsewhere. The Kuznets curve is a controversial concept in environmental economics which purports to demonstrate that the incidence of pollution can eventually decline as a country’s per capita income rises, thus breaking the link between economic growth and incremental environmental damage and decay.

Indeed developing countries might achieve a fall in pollution at a relatively low level of per capita output and incomes if they are able to take advantage of the knowledge they have about the mistakes developed countries made. The Kuznets curve is based on the fact that growth increases the wealth of governments and firms allowing them to put more money into research and development, and hence to produce cleaner and more efficient methods of production.

An example of this is in the car industry. Catalytic converters and improved engines have lead to cars polluting less and increasing their ‘miles per gallon’. This is a result of government introducing legislation making it a legal requirement to have a catalytic converter and using taxes to create a demand for fuel efficient cars (in countries such as Kuwait where oil is cheap there is far less incentive to buy fuel efficient cars).

One link between growth and the environment which lends weight to the Kuznets argument concerns the effect that development has on the natural rate of population growth. Economic growth has been closely correlated to demographic changes. Developed countries have lover birth rates hence reducing the pressure on scarce resources. Ecologists argue that with economic growth comes unrectifiable damage to the environment. This damage, they argue, outweighs the benefits of growth and can cause standards of living to fall.

A key problem is that it remains extremely hard to quantify in monetary terms the damage that is done to the environment – there are missing markets for many of our most cherished environmental resources. A new approach to pollution measurement and control now being introduced in the UK to many industries is the selling of licences to pollute from the government; through an auction or similar method, companies purchase licences which give them the right to pollute.

This not only makes firms more aware of their pollution and forces them to become more environmentally efficient, but also forces inefficient firms out of the market because their costs will be high due to the pollution. Another benefit in this method of controlling pollution goes to the efficient companies who can sell the pollution permits to the inefficient companies, possibly for prices even more than what they purchased them for.

The debate over the costs and benefits of economic growth can never be settled conclusively, in part because we simply do not have enough information on both the quantity and quality of our environmental resources – are the environmental pessimists over-stating the damage that growth is doing to our planet? Are economists who are much more sanguine about the impact of growth undervaluing the importance of leaving a sustainable environment to future generations?

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