conomic Growth 

Introduct ion 

lis article primarily intends 
to p r o v i d e an e l emen ta ry 

JL knowledge and understanding 
of some of the basic theoretical 
aspects of economic growth for the 
students offering Economics as a 
subject for GCE Advanced Level and 
the university undergraduates. The 
fo l lowing a s p e c t s of e c o n o m i c 
growth are covered in this article: 
(a) definition of economic growth, 
• h) measuring of economic growth, 
K ) benefits of economic growth, (d) 
causes of economic growth, (e) 
pol ic ies o f p romot ing economic 
growth, and (f) costs of economic 
growth. 

Defining Economic Growth 

Economic growth is an increase in 
the production capacity of goods and 
services of an economy. The more 
food, clothing, housing, cars and 
medical services a country can 
p r o d u c e , the bet ter off tha t 
country's citizens will be. Economic 
growth will increase the availability 
of these types of products over 
time, resulting in higher standard 
of living. From a theoretical point 
of view, economic growth can be 
defined as an expansion of the 
p r o d u c t i o n c a p a c i t y or the 
potential output of an economy. 
There are two ways of presenting 
the concept of economic growth. The 
first is in t e rms of product ion 
possibili ty frontier as shown in 
Figure 1 where economic growth is 
characterised as an outward shift 
of the p r o d u c t i o n poss ib i l i ty 
frontier from PPF, to PPF 2 . In other 
words, economic growth enables a 
country to produce more goodsland 
services in any given period as a 
resul t of an expans ion of i ts 
production capacity. 

The second way of presenting the 
concept o f e c o n o m i c growth in 

Figure 1 Economic Growth-
Shift in production possibility 
frontier 

terms of aggregate supply as shown 
in F igure 2 . E c o n o m i c g rowth 
involves a rightward shift in the 
e c o n o m y ' s long- run agg rega t e 
supply curve. This corresponds to 
an increase in the economy's level 
of potential output. An increase in 
the economy's resource endowment 
and p roduc t i v i t y wi l l e n a b l e 
p roduc t ion of more goods and 
services at any given price, so that 
the aggregate supply curve will shift 
outwards from A S t to A S 2 . This 
en ta i l s an inc rease in full 
employment output (or potential 
output) from Yl to Y 2 . 

Prof. Danny Atapattu 
Senior Professor in Economics, 

University ofRuhuna 

increase in real output of a country. 
Thus, economists use two methods 
to measure economic growth; (i) 
the increase in real GNP (Gross 
Na t iona l P r o d u c t ) or N N P (Net 
National Product) which occurs 
over a period of time and (ii( the 
increase in real GNP or NNP per 
capita which occurs over time. Both 
measures are useful. For example, 
if we a re c o n c e r n e d wi th the 
question of military potential or 
poli t ical pre-eminence , the first 
measure is more relevant. But per 
capita output growth is clearly 
superior for comparisons of living 
s t a n d a r d s a m o n g na t ions or 
regions. Economic growth by either 
measurement is usually calculated 
in terms of annual percentage rates 
of growth. For example, if real GNP 
was Rs. 200 billion last year and is 
Rs. 210 billion this year, we can 
calculate the rate of growth by 
subtracting last year 's real G N P 

from this year's real GNP, 
d iv id ing the difference by 
last year ' s real GNP and 
multiplying by 100, i.e., ((210 
- 2 0 0 ) / 2 0 0 ) x l 0 0 , or 5 
percent. 

Figure 2 Economic Growth: 
A Shift in Aggregate Supply 

M e a s u r e m e n t 
Growth 

of E c o n o m i c 

Let us now discuss the best way of 
measuring growth. In a statistical 
sense , e c o n o m i c g r o w t h is an 

If economists try to measure 
economic growth using the 
rate of change of real GNP 
or per capita real GNP as an 
i n d i c a t o r , they are not 
necessarily measuring what 
they want to. GNP growth 
measures the actual rate of 

change of output rather than the 
g rowth of the potential ou tpu t 
capacity of the economy. In Figure 
3, a movement from point A to point 
B represents a move to the frontier. 
This is an increase in actual output 

Economic Review: June/July 2011 
36 



Consumer Goods 

PPF„ 

0 Capita] Goods 

Figure 3 Different forms of Economic 
Growth 

resulting from using up surplus 
capacity in the economy, but it is 
not e c o n o m i c g r o w t h in the 
theoretical sense, as moving from 
point A to point B does not entail 
an increase in productive capacity. 
In contrast , the shift ing of the 
frontier itself, enabling the move 
from point B to po in t C, does 
r ep re sen t e c o n o m i c g r o w t h . 
However, when economists observe 
a rate of change in real GNP, they 
cannot easily distinguish between 
the two types of effects, especially 
when the economy is subject to a 
bus iness cycle . It is therefore , 
better to measure economic growth 
in terms of growth of real GDP 
(Gross Domestic Product). 

Benefits of Economic Growth 

Economic growth means increase in 
rea l output . It p r o v i d e s the 
following benefits: 

i. Increasing incomes: The growth 
o f total ou tpu t r e l a t i v e to 
popu la t ion m e a n s i n c r e a s i n g 
standard of living. An expansion of 
real output enables consumers to 
enjoy more goods and services. 

ii. Lowering unemployment: 
With higher output, firms tend to 
employ more workers, creating more 
employment opportunities. 

iii. Reducing government 
borrowing: E c o n o m i c g r o w t h 
creates higher tax revenues and 
hence the need b o r r o w i n g to 
finance government expenditure 
will reduce. 

iv. Reduction of 
poverty: A g r o w i n g 
economy can undertake 
new p r o g r a m m e s to 
alleviate poverty. 

v. Improving public 
services: With increased 
tax r e v e n u e s , the 
g o v e r n m e n t can spend 
more on the provision of 
public goods and merit 
g o o d s such as 
i n f r a s t r u c t u r e 

d e v e l o p m e n t , hea l th care , 
education, etc. 

vi. Protection of environment: 
A growing economy can allocate 
more funds for c l ean ing up of 
environment without impairing the 
exis t ing levels of consumpt ion , 
i n v e s t m e n t and pub l ic g o o d s 
production. 

vii. Lessening the burden of 
scarcity: A g r o w i n g e c o n o m y , 
unlike a static one, can consume 
more wh i l e s i m u l t a n e o u s l y 
increasing its capacity to produce 
more in the future. 

Causes of Economic Growth 

Theoretically, the determinants of 
economic growth are the factors 
that can shift the P r o d u c t i o n 
Possibility Frontier (PPF) or the 
Long-Run Aggregate Supply (LRAS) 
curve to the right. These factors 
include; (a) quantity and quality of 
natural resources (b) quantity and 
qual i ty of human resources (c) 
s tock of p h y s i c a l cap i t a l (d) 
e n t r e p r e n e u r i a l ab i l i ty (e) 
technological knowledge (f) property 
r ights s t ruc ture (g) e c o n o m i c 
freedom. These items may be called 
supply factors in economic growth. 

i. Natural resources: Na tu ra l 
r e sou rce s are those inpu t s of 
production that are provided by 
nature, such as land, rivers, and 
m i n e r a l d e p o s i t s . Na tura l 
r e sou rce s take two fa rms: 
renewable and non-renewable. 

ii. Human capital: Human capital 
is the knowledge and skills that 
workers acquire through education, 
training and experience. 

ill. Physical capital: The stock of 
equipment and structures that are 
used to produce goods and services 
is called physical capital. 

iv. Entrepreneurial ability: The 
human resource that organise land, 
l abou r and cap i t a l is ca l led 
entrepreneurship. Entrepreneurs 
come up with new ideas about what 
and how to produce, make business 
decisions, and bear the risks that 
arise from these decisions. 

v. Social capital: Social capital 
refers to those s tocks of social 
trust, norms and networks that 
peop le can draw upon to solve 
common problems. Ne tworks of 
c iv i c e n g a g e m e n t , such as 
neighbourhood associations, sport 
c lubs and c o o p e r a t i v e s are an 
essential form of social capital, and 
the denser these ne tworks , the 
more l ikely that m e m b e r s of a 
c o m m u n i t y wi l l c o o p e r a t e for 
mutual benefit. Social capital is 
p r o d u c t i v e , s ince two fa rmers 
exchanging tools can get more work 
done with less physical capital; 
rotat ing credit associa t ions can 
generate pools of financial capital 
for i n c r e a s e d e n t r e p r e n e u r i a l 
activity; and job searches can be 
more efficient if in format ion is 
embedded in social networks. 

vi. Technological knowledge: 
Techno log ica l knowledge is the 
understanding of the best ways of 
p r o d u c i n g goods and se rv ices . 
Technological knowledge may take 
many forms. Some technology is 
c o m m o n k n o w l e d g e - af ter it 
b e c o m e s used by o n e pe r son , 
e v e r y o n e b e c o m e s aware of it. 
Other technology is proprietary - it 
is known only by the company that 
discovers it. Still other technology 
is propr ie tary for a shor t t ime. 
When a pharmaceutical company 
discovers a new drug, the patent 
system gives that company a 

37 
Economic Review: June/July 2011 



^mporary right to be its exclusive 
inanufacturer. When the patent 
expires, however, other companies 
•ire allowed to make the drug. All 
Vhese forms of t e c h n o l o g i c a l 
knowledge are important for the 
economy's production of goods and 
services. 

v. Property r ights s tructure: 
Property rights refer to the laws, 
rules, and regulations that define 
rights for the use and transfer of 
resources. Consider two property 
right structures. In one structure, 
people are allowed to keep the full 
monetary rewards of their labour, 
in the other, people are allowed to 
keep only half. Many economists 
would predict that the first property 
rights structure would stimulate 
more economic activity than the 
second. 

vii. Economic freedom: Some 
economists believe that economic 
freedom leads to economic growth. 
Countries in which people enjoy a 
higher degree of economic freedom 
develop and grow more quickly than 
countries in which people have 
lesser e c o n o m i c f r eedom. The 
Heritage Foundation and the Wall 
Street Journal have joined together 
to produce an "index of economic 
freedom." The index is based on 50 
independent variables divided into 
10 broad categories of economic 
freedom, such as t rade policy, 
monetary policy, property rights 
structure, regulation, fiscal burden 
of government, and so on. The data 
show that economic freedom and 
real GNP per capita are correlated. 

The above-mentioned factors that 
can shift the production possibility 
frontier to the right may be termed 
the supply factors in economic 
growth. They are phys ica l and 
institutional e lements that can 
enhance p r o d u c t i o n and 
productivity. But the ability to grow 
and the actual realisation of growth 
may be quite di f ferent th ings . 
Spec i f ica l ly , two add i t i ona l 
cons ide ra t i ons con t r i bu t e to 
growth. First, there is a demand 

38 

factor in growth. To realise its 
g rowing product ive potential , a 
country must provide for the full 
employment of its expanding supply 
of r e s o u r c e s . Th i s r equ i re s a 
growing level of aggregate demand. 
Second, there is an a l locat ive 
factor in growth. To achieve its 
product ive potential , a country 
must provide not only for the full 
employment of its resources, but 
also for full production from them. 
The ability to expand production is 
not a sufficient condition for the 
expans ion of total output . T h e 
actual employment of expanded 
r e source suppl ies and the 
al location of those resources in 
such a way as to get the maximum 
amount of useful goods produced 
are also required. 

Policies of Promoting Economic 
Growth 

Promoting economic growth means 
shifting rightward the production 
possibility frontier or the long-run 
aggregate supply curve. Therefore, 
the policies of promoting economic 
growth should aim at enhancing 
r e sou rce e n d o w m e n t and 
productivity. Such policies include; 
(a) p r o m o t i n g sav ings and 
investment, (b) encouraging foreign 
i n v e s t m e n t , (c) i n v e s t m e n t in 
h u m a n cap i ta l , (d) p r o t e c t i n g 
proper ty r ights and p romot ing 
political stability, (e) l iberalising 
t rade , (f) l o w e r i n g taxes and 
r e d u c i n g regu la t ion , and (g) 
p r o m o t i n g resea rch and 
development. 

i. P r o m o t i n g s a v i n g s a n d 
investment: Because capital is a 
produced factor of production, a 
country can change the amount of 
capital it has. Thus, one way of 
raising future productivity is by 
investing more current resources 
in the production of capital. To 
raise the level of capital stock of 
the economy, it requires that the 
coun t ry sacr i f ice the p r e s e n t 
consumption of goods and services. 
Encouraging saving and investment 

through m o n e t a r y and fiscal 
po l i c i e s is one way that a 
government can encourage growth. 

ii. E n c o u r a g i n g fore ign 
investment: Saving by domestic 
residents is not the only way for a 
country to invest in new capital. 
The other way is investment by 
foreigners. Investment from abroad 
take severa l fo rms . A capi ta l 
i nves tmen t that is owned and 
operated by a foreign entity is called 
fore ign d i rec t i n v e s t m e n t . An 
investment that is financed with 
foreign money but operated by 
domestic residents is called foreign 
portfolio investment. In both cases, 
foreign inves tors cont r ibute to 
increase the domes t i c stock of 
capital. 

i i i . I n v e s t m e n t in h u m a n 
capital: Education - investment in 
human- cap i t a l is at leas t as 
impor t an t as i n v e s t m e n t in 
physical capital for a country's long-
run economic success. One way in 
which g o v e r n m e n t po l i cy can 
enhance the standard of living is 
by provid ing good schools and 
quality education and encouraging 
the population to take advantage of 
them. 

iv. Protecting property rights 
and p r o m o t i n g po l i t i ca l 
stability: Property rights refer to 
the ability of people to exercise 
authority over the resources they 
own . For th is r ea son , j ud i c i a l 
system serves an important role in 
a market e c o n o m y . It enforces 
property rights, ensuring buyers 
and se l lers l ive up to the i r 
contracts. In many countries, the 
system of justice does not work 
well. Contracts are hard to enforce, 
and fraud often goes unpunished. 
To do business in some countries, 
firms are expected to bribe powerful 
government officials and ministers. 
Thus, economic prosperity depends, 
in part, on political prosperity. A 
country with an efficient judiciary 
sys t em, hones t g o v e r n m e n t 
officials and a stable constitution 
will enjoy a higher economic 

Economic Review: June/July 2011 



standard of living than a country 
with a poor j u d i c i a r y sys tem, 
corrupt of f ic ia l s and uns tab le 
political system. 

v. L i b e r a l i s i n g t rade: Mos t 
e c o n o m i s t s today be l i eve that 
countries are better off pursuing 
ou tward -o r i en t ed po l i c i es that 
integrate these countries into the 
world economy. Trade is, in some 
ways, a type of technology. When a 
country exports tea and imports 
steel, the country benefits in the 
same way as if it had invented a 
technology for turning tea into 
steel. A country that el iminates 
trade restrictions will , therefore, 
exper ience the same k ind of 
economic growth that would occur 
after a major technological advance. 

vi. R e d u c i n g taxes a n d 
regulations: The reduction of tax 
rates and r egu l a t i ons wou ld 
encourage private investment. 

vii . P r o m o t i n g r e s e a r c h a n d 
development: The primary reason 
that living standards are higher 
today than they were century ago 
is that technological knowledge has 
a d v a n c e d . A l t h o u g h mos t 
technological advances come from 
pr ivate research by firms and 

ind iv idua l i n v e n t o r s , the 
g o v e r n m e n t has a ro le in 
e n c o u r a g i n g the r e sea rch and 
development of new technologies. 
Using its fiscal policy instruments, 
the g o v e r n m e n t can gran t 
incentives to encourage research 
and development. Another way in 
which g o v e r n m e n t po l icy 
encourages research is through the 
pa t en t sy s t em. By a l l o w i n g 
i n v e n t o r s to prof i t f rom the i r 
i n v e n t i o n s , the pa t en t sys tem 
e n h a n c e s the i n c e n t i v e for 
individuals and firms to engage in 
research. 

D i s a d v a n t a g e s o f E c o n o m i c 
Growth 
In recent years, serious questions 
have been ra ised a b o u t the 
desirability of continued economic 
g rowth for a l r eady aff luent 
societies. The following interrelated 
a r g u m e n t s c o m p r i s e the anti-
growth sentiment: 

i. Environmental concerns: Fast 
g r o w t h o f p r o d u c t i o n and 
consumption can create negative 
e x t e r n a l i t i e s (for e x a m p l e , 
i nc reased noise and l o w e r air 
quality arising from air pollution 
and road congestion, rapid growth 
of household and industrial waste). 

Growth that leads to environmental 
damage can have a negative effect 
on the people's quality of life and 
m a y a l so i m p e d e a c o u n t r y ' s 
sustainable rate of growth. 

i i . H u m a n o b s o l e s c e n c e : T h e 
changing technology that is the core 
of growth, poses new anxieties and 
new s o u r c e s of insecur i ty for 
workers. Bath high-level and low-
level workers face the prospect of 
having their hard-earned skills and 
experience made obsolete by an 
o n r u s h i n g t e c h n o l o g y , thus 
becoming structurally unemployed. 

i l l . O p p o r t u n i t y cost: T h e 
opportunity cost of higher economic 
growth is the sacrifice of current 
consumption which could otherwise 
h a v e been en joyed . C u r r e n t 
consumption is being sacrificed to 
a c h i e v e a h igher ra te of 
consumption in the future. 

iv. Inflation risk: If the economy 
grows too fast too quickly, there is 
the danger of inflation as demand 
raises ahead of aggregate supply. 

v. I n e q u i t y in I n c o m e 
d i s t r i b u t i o n : Rap id e c o n o m i c 
growth could result in disparities 
in income distribution. H 

p l a c e , at l eas t in d e v e l o p e d 
countries with significant chemical 
industries. 

Allowing for the fact that several 
States have yet to sign or ratify the 
CWC, the treaty works well, and 
has made the world a safer place 
dur ing the past 14 years or so. 
However, the frightening possibility 
that a terrorist organisation may 
acquire chemical weapons looms 
o v e r us . T h e answer l ies in 
i n t e r n a t i o n a l c o o p e r a t i o n , 
m e t i c u l o u s m o n i t o r i n g , and 
unending vigilance. 

Acknowledgement 

T h e author thanks the OPCW for the 
opportunity to undergo training in their 
Associates program in 2004. 

• 

Contd. from page 31 

manufacture sarin. Their first major 
use of it w a s in 1994, at an 
apartment complex in Matsumoto, 
apparently chosen because a judge, 
who was hearing a case against 
them, lived there. Eight people died 
and over 200 were hospitalised, but 
investigators failed to identify the 
Aum Shinrikyo as the culprits. Their 
next attack was the spectacular, 
coordinated release of sarin on five 
trains in the Tokyo subway system, 
on the 2 0 t h of March, 1995. This 
resulted in 12 deaths and over 1,000 
injuries. This time, the police were 
finally ab le to ident i fy those 
responsible, and Shoko Asahara 
was tried and sentenced to death. 

Organ i sa t i ons exis t , w h e t h e r 
formally labelled "terrorist" or not, 

which do not consider themselves 
to be bound by in t e rna t iona l 
treaties or national laws, and for 
whom chemical weapons may be a 
cheap and easy way of developing 
the capacity to carry our major 
a t t acks aga ins t u n p r o t e c t e d 
civilians. The actions o f the Aum 
Shinrikyo have brought this fact to 
the wor ld ' s a t t en t i on in no 
uncertain terms. While the CWC is 
designed to cover this eventuality, 
it can only succeed with the willing 
cooperation at the highest level of 
its signatories, and the alertness 
of the O P C W , the Na t iona l 
Author i t ies , and the numerous 
a g e n c i e s c h a r g e d wi th 
implementing the C W C , such as 
customs, law enforcement, defence, 
and intelligence agencies of member 
States. These factors are mostly in 

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Economic Review: June/July 201 1