# What is the relevance of economic growth?

Economic policies often mention high economic growth as a desirable path. For example,

"We started to lay a new foundation for stronger, more durable economic growth."

-- President Obama, Speech in 2013

But also

"Jeb Bush pledged Monday to give the U.S. an economic growth rate of 4 percent a year"

-- Politico

and many others in the USA and abroad (Hollande, Merkel, etc.)

Politicians from different sides seem to agree that economic growth is desired. For example, some of them say that growth helps against misery. Some of them say that higher growth helps a government with paying back their debt.

How does economic growth help the economy and the society? Through which mechanism does that work?

• This is part of two questions. I felt that people always tried to ask these questions here (see the many questions on growth), but we shut them down as they weren't using the right words / asking the right question. I hope that these two basic questions gets some high quality answers as they are the central point of misunderstanding between "capitalists" and "anti-capitalists" – FooBar Jul 15 '15 at 6:55
• possible duplicate of Are there fundamental reasons why (exponential) economic growth is highly desirable? – gerrit Jul 15 '15 at 15:56
• @gerrit it appears similar, but I find that question poorly phrased. It has this focus on growth being exponential, and if you remove that part, all you're left with is a single phrase. I would guess that explains why there's only one answer with positive votes, and even that one I dont find satisfactory. – FooBar Jul 15 '15 at 16:38
• @FooBar Perhaps it is poorly phrased. The intention with the question is identical. – gerrit Jul 15 '15 at 17:15

World population currently is estimated at $7.3$ billion people, while world GDP at $74.5$ trillion USD (nominal). So the global average of per capita GDP currently stands at USD $10,205$, again nominal, not adjusted for purchasing-power-parity. But in any case, this number, although not negligible, it is small enough so that, even if we had absolute global equidistribution, we would hardly be in an "Affluent Society".

This alone could justify why Growth is still the main economic target of societies all over the world: even if inequality was out of the picture, we will still be far from living really "comfortably".

Add inequality to the picture, and one realizes that Growth is also seen as something that can help mitigate possible social tensions due to inequality: one accepts the existence of inequality easier, if ones sees his own fortunes getting better (this requires of course that everybody gets something out of Growth, even in unequal shares).

• What would you say to 'happiness economics' researchers who argue that subjective well-being doesn't seem to change much as economies become richer, and only depends upon relative wealth comparisons to immediate neighbours?Also, do you have a remark on the casual observation that the payoffs to growth have been disproportionately captured by the wealthiest so that growth has gone hand-in hand with increasing inequality over the lat 80 years? – Ubiquitous Jul 16 '15 at 16:38
• @Ubiquitous That if they are indeed right, people (and hence, their politicians) don't want to know about it (although the belief that well-being is/should become largely independent of material goods is engrained in many and diverse ethical/philosophical systems). My response as regards how the spoils of growth are divided, is that how growth is realized, matters for its eventual distribution. And, it feeds back. This is something that recently has become under theoretical investigation in the growth literature. – Alecos Papadopoulos Jul 16 '15 at 17:28
• I feel this argument misses on one dimension: It is agreed that there is a fundamental tradeoff between equality and efficiency, between equality and growth. So we set incentives for growth (by accepting inequality), in order to decrease inequality? Not necessarily a contradiction, but an issue worth mentioning. – FooBar Jul 17 '15 at 11:18
• @FooBar I wouldn't say "in order to decrease" inequality but, "attempting to decrease" its possible detrimental effects on social cohesion. – Alecos Papadopoulos Jul 17 '15 at 11:23

A couple of weeks ago I read a very good, in my opinion, speech on growth.

While far from the quality of the aforementioned speech, I'm going to try to answer the questions in a shorter and simpler way.

Economic growth helps the economy by shifting the production possibility frontier (PPF) outwards, meaning more can be produced, and therefore consumed, with the limited amount of inputs available. Of course this assumes that the utility function of the agents in the economy is increasing with the amount of goods and services consumed. Through this increase in total utility is how growth helps society.

When it comes to discussing the mechanisms through which the above works, I feel a discussion of growth models is unavoidable. The PPF is shifted outwards with growth mainly due to an increase in technological progress, which, in exogenous growth models, like the Solow-Swan model, dictates the growth rate when the economy is a steady state (SS). Basically the increase in technological progress increases productivity and the same output can be produced with less amount of labor and capital. The newly available factors of production can now be allocated to produce other goods and services. Assuming the savings rate in the economy is unchanged, the level of consumption increases.

Where does the growth in technological progress come from? To know that, we either have to accept that we get waves of innovation, like the industrial revolution, from an unidentified source or we have to look into endogenous growth models. Examples of such models are the simple AK model or a more realistic model which includes human as well as physical capital as parameters in the production function, see here.

In a previous question, the economic growth has been explained to be a rise of the GDP as a function of time. The answers to the said question discusses the mechanisms or parameters which influence the GDP, and which can contribute to its rise.

First let's clear the situation of the inflation away from the remainder of the discussion. Then we will try to see the advantages for a society of an economic growth, and finally we will discuss the pertinence of those perceived advantage, and some alternative theories.

## Inflation

The measure of the GDP is based on the prices of products and services. As such, it is very dependent on the inflation. Indeed, everything else being equal, the increase in GDP should be exactly the inflation rate.

Effect of the inflation on the society

The inflation corresponds to the overall increase of prices within a country, typically from one year to the next. There are various effects on the inflation, and here is not the place to discuss all of them. We will just mention two

• Debts: due to the inflation, the relative value of debts decreases. So people or countries who have debts benefit from the inflation, as they are required to pay conparatively less. That is a way in which

Transfers Money from Savers and Investors to Debtors (source)

which make the capital more active for the economy.

• Lower acquisition power: if the income stays constant, one gets less of one month's work. This is argued to be a natural adjustment of income, as it can effectively be reduced, without actually reducing it.

Thus, some inflation might be wanted, and this, in consequence, favours an increase of the GDP.

But most of the time, the economic growth is corrected for the inflation. And so will we discuss in the rest of the post.

Now that we are inflation free, what are the advantages of an growth?

One has to keep in mind that a growth is a consequence of changes in the economy, not the cause. Without trying to be fully exhaustive, one can the following points which would explain the growth:

• lower unemployment: with more people working, the government needs to spend less on social helps, collects more taxes and thus can spend more in public contracts, or any other public investment. Furthermore, it means more people have more money to consume.
• higher salaries: similar to above, higher salaries mean more consumption and investment.
• Improved public finances: either less debt, or more savings, which in turn mean more spending (e.g. improving services or reducing taxes).

Higher salaries, richer state and lower unemployment, mean a reduction of poverty, and has been associated to increase the happiness of the population and even to improved quality of life. This is understood by having better services and health system, changing to a primarily agricultural economy to one based on services, improved the health condition, and combined with an improve wealth, is associated with happiness and better life quality.

Politicians who are (at least indirectly1) concerned with their citizens happiness and life quality, strives to create economic growth. Even without the relation to happiness and life quality, policies which aims at reducing the unemployment are perceived as positive by the voters.

## Discussion

However all those benefits of growth are subject to debate. I don't want to give too many details, as many points are given in Wikipedia and the references therein.

In particular,

• a strict relation between the GDP and happiness is a subject of discussion;
• the quality of life isn't directly related to the spendings by the state, or the perceived income;
• poverty isn't necessarily positively affected by rise of GDP;

and even the most direct factors are not necessarily included in an ecoomic growth, namely lower unemployment and higher salaries. For most of those to actually take place, the generated extra revenue (growth ca be seen as a revenue), isn't necessarily equally distributed.

To put it in a simple way, if the rich become richer, they won't be fundamentally much more happy. But the poor will at best stay as unhappy as before.

In a previous answer, I already discussed why GDP is not a good measure.

Furthermore, the economic growth is also associated to negative effects, mostly related to ecological issues. As a consequence, some claim that we should strive for a degrowth, due to the claim of unsustainability of a continuous economic growth.

1. Indirectly: if the voters are happier, they are more likely to vote for them, and thus for them to stay in power.

I think it's clear why a nation should aspire for economic growth. It's competition with other nations. Given that most other countries are growing, if you don't, then soon you will be unable to trade with them, which will lead to poverty in your own coutnry. Why the entire world as a whole needs to grow is a different issue. I don't think the world needs to grow, but it just happens to grow because of, again, competition at every level

• Please bring some evidence for the claim "if you don't, then soon you will be unable to trade with them" – FooBar Jul 15 '15 at 15:39