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02 Economicgrowth
02 Economicgrowth
Economic growth is defined as the percentage change in an economys GDP or GNP values.
Therefore, growth measures the change in an economys total value of goods and services
produced during a given period of time. Economic growth is anindicatorofeconomicprogress.
Growth rates vary substantiallyfrom countrytocountry.TheFigurebelowshowsquarterlyGDP
growthratesasofJune2014for51countrieswhereIndiaranks46.
Source:TradingEconomics.com
A closely related concept is the growth rate of output per person which determines the rate at
which a countrys living standards are improving. A growth in per capita output leads to rising
average income. TheratiosofGrossNationalIncome(GNI)PercapitatoGrossNationalincome
for 2013for43countriesare plottedinthediagrambelow.Itshowsthatdespitehavingvery high
GDPgrowthrates,IndiaandChinahavethelowestGNIPercapitaamongtheselectedcountries.
Economic growth occurs when a countrys production possibility frontier (PPF) shifts outward.
The PPF shows the maximum quantity of goodsthatcanbeproducedefficientlybyaneconomy
given its technological knowledge and the quantity of available inputs. If we assume there are
two commodities (or commodity baskets) that an economy wants to produce, then PPF shows
variouscombinationsofbothproductsthatcanbeproducedwiththeavailableresources.
Source:WorldBank.org
PPF
The two intercepts show two possibilities where the economy produces only one of the two
commodities. Along the curve we have various combinations of both commodities produced
using all the resources. Any point below the curve represents under utilization of resources and
any point above the curve is not an attainable levelofproductionforthecountry. Anincreasein
inputs or technologicalimprovements,indicatingeconomicgrowth,enablesacountrytoproduce
moregivenotherresources.Therefore,thePPFshiftsoutward,shownbythedashedlineabove.
If the two commodities can be considered as public and private goods, then a poor country
having limited resources, can hardly afford public goods like public health, education,
infrastructure facilities etc. They will devote most of their resources for producing goods of
private consumption like food, clothing etc. If
X and
Y are goods of public and private
consumption, respectively, then a poorer country will produce a combination close to the
x
axis
Q/L
0
Q/L
i
APF/
APF
K/L
iK/L
K/L
by
Qt
= Tt
Kt
where
t denotes time period,
Q
is real output,
T
,
K and
L are indices of
Lt
technology, capitalstock (inrealterms)andlabourinput(intermsofmanhours),respectively
<1.Nowthatwhenexpressedintermsof
growthratestheCobbDouglasProductionfunctiontakesthefollowingform:
dlnQt
dlnT t
dlnKt
dlnLt
dt = dt + dt + dt
Or
g
g
denotesgrowthrates
Q=g
T
K+
L where
For a given technology the function takes the form of usual neoclassical production function
with two inputs,
K
and
L. However, the change in output caused by change in technological
innovation is called total factor productivity (TFP). Alternatively, TFP is defined as the portion
of output not explained by the amount of inputs used in production. TFP growth is usually
measured by the Solow residual. The Solow residual accurately measures TFP growth if (i) the
production function is neoclassical, (ii) there is perfect competition in factor markets, and (iii)
thegrowthratesoftheinputsaremeasuredaccurately.
Sometimes, the CobbDouglas production function is estimated with the assumption ofconstant
returns to scale, so that the model has a constraint of
+
= 1. Now,
=1
.Thisiscalleda
constrained CobbDouglas production function. Let
gQ
denote the growth rate of aggregate
output,
gK
the growth rate of aggregate capital,
gL
the growth rate of aggregate labor and alpha
thecapitalshare.TheSolowresidualisthendefinedas
g
(1
)
g
Qg
K
L.
The Figure below shows changes in Indias TFP over the years 1994 till 2012. The situation
warnedofadecliningTFPwhichimpliesadeclineinthecompetitivenessofaneconomy.
The reasons for slowdown in TFP are many including administrative and bureaucratic tangles,
poor infrastructure, barriers to investment, unskilled labour force, lack of innovation, persistent
inflation, current account deficit, and slow growth in private investment. The diagram below
showsthepatterninthechangeinsavingsandinvestment.
AnnualGrowthRateofTFPbyBroadSector,19802008
BroadSectors
TotalFactorProductivity
Agriculture,Hunting,Forestry,Fishing
1.68
Mining&Quarrying
0.17
Manufacturing
1.30
Electricity,Gas&WaterSupply
2.62
Construction
3.31
Services
TotalEconomy
2.07
1.74
RBIs report on productivity growth in the Indian context shows that TFP growth has been
negative for construction and mining and quarrying see above table. One ofthemost important
structural constraints has been low agricultural productivity growth. India also has a sizeable
informal sector which suffers from low productivity because of lackofeasyaccesstocreditand
technology.
An alternative view however, claims that TFP, at constant price with 2005 as the base year, is
continuouslygrowinginIndiaasshowninthefollowingfigure.