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Economic Growth - Costs and Benefits

Author: Geoff Riley  Last updated: Sunday 23 September, 2012

Economic Growth and Structural Change in Developing Countries

Advantages of Economic Growth

Growth has a number of economic and social benefits:

Improvements in living standards: Growth is an important avenue through which per capita incomes can rise and absolute poverty can be reduced in developing nations. Professor Paul Collier has argued that “growth is not a cure-all; but the absence of growth is a kill-all”

More jobs: Growth creates new jobs – although the pattern of employment will also change

The accelerator effect of growth on capital investment: Rising demand and output encourages investment in capital – this helps to sustain GDP growth by increasing LRAS

Greater business confidence: Growth has a positive impact on profits & business confidence

The “fiscal dividend”: A growing economy boosts tax revenues and generates the money to finance spending on public and merit goods and services without having to raise tax rates.

Potential environmental benefits – as countries grow richer, they have more resources available to invest in cleaner technologies. And, as nations develop, energy intensity levels fall.

Benefits from growth driven by technological change

 

Disadvantages of Economic Growth

There are economic and social costs of a fast-expanding economy.

Inflation risk: If demand races ahead of aggregate supply the scene is set for rising prices – many of the faster-growing countries have seen a trend rise in inflation – this is known as structural inflation

Environmental concerns:

  • Fast growth can create negative externalities for example more noise pollution and lower air quality arising from air pollution and road congestion
  • Increased consumption of de-merit goods which damage social welfare
  • The huge increase in household and industrial waste. These externalities reduce social welfare and can lead to market failure.

Growth that leads to environmental damage may lower the sustainable rate of growth.  Examples include the destruction of rain forests through deforestation, the over-exploitation of fish stocks and loss of natural habitat and bio-diversity created through the construction of new roads, hotels, retail malls and industrial estates.

Growth and the Environment: The Sustainability of Economic Growth

Many of the world’s most valuable finite resources are being extracted at such a rate that it questions the sustainability of growth. Renewable resources are also being depleted because of over-consumption.

Examples include the destruction of rain forests, the over-exploitation of fish stocks and loss of natural habitat created through the construction of new roads, hotels, retail malls and industrial estates. Some of the main environmental threats include:

    • The depletion of the global resource base and the impact of global warming. There are plenty of examples of the “tragedy of the commons”; the permanent loss of what should be renewable resources from over-extraction of some of our environmental resources.
    • A huge expansion of waste and pollution arising from both production and consumption
    • Over-population (particularly in urban areas) putting increased pressure on scarce land and other resources. More than half of the world's population lives in cities in 2009, most of them in developing countries according to the United Nations Population Fund.
    • Species extinction leading to a loss of bio-diversity - Scientists predict that at least a third and as much as two-thirds of the world's species could be on their way to extinction by the end of this century, mostly because people are destroying tropical forests and other habitats, over-fishing the oceans and changing the global climate.

Economic Growth and Income and Wealth Inequality

Not all of the benefits of growth are evenly distributed. A rise in real GDP can often be accompanied by widening income and wealth inequality in society that is reflected in an increase in relative poverty.

The Gini coefficient is one way to measure the inequalities in the distribution of income and wealth in different countries. The higher the value for the Gini co-efficient (the maximum value is 1), then greater the inequality. Countries such as Japan, Denmark and Sweden typically have low values for the Gini coefficients whereas African and South American countries have an enormous gulf between the incomes of the richest and the poorest elements of the population.

When economists look at data on income and income inequality they nearly always focus on median rather than mean incomes per capita. The reason is that the very uneven distribution of income means that there are people who earn astounding salaries and wages and the income of the super-rich tends to drive up mean incomes. For example, In the United States, mean income is almost a third higher than median income, and the gap is growing. This was a factor behind the rise to prominence of the Occupy protest movement in the USA.

Why can rapid growth often lead to a widening of inequalities in both developed and developing countries?

  • High increases in pay of people in top-paying jobs
  • Increasing wealth including rising property prices
  • Growing gaps between urban and rural areas
  • High fertility in poorer households
  • Increasing pay of those with higher levels of schooling especially with the growth of jobs and pay in high-knowledge industries such as computer gaming, engineering systems, financial trading
  • Reductions in the percentage of people who are members of a trade union
  • Linked effects of inequality in health and education

Much depends on the extent to which a government has a welfare and tax system in place to provide an income safety-net and also a desire to redistribute rising incomes and wealth so that the benefits of growth can be more equitably shared out.

Economic and Social Costs from Rising Inequality

In 1980, the per capita income of the 15 richest nations was 44 times that of the 15 poorest, by 2000, that multiple had increased to 62. However in 2009, reflecting better economic performance in several developing and transition countries; the ratio had fallen to 56

The Kuznets Curve

  • The Kuznets Curve was established by the economist Simon Kuznets and it dates from the 1950s.
  • It suggests that in preindustrial societies, almost everybody is equally poor so inequality is low. Inequality then rises as people move from low-productivity agriculture to the more productive industrial sector, where average income is higher and wages are less uniform.
  • As a society develops and becomes richer, the urban-rural gap is reduced and old-age pensions, unemployment benefits, and other components of a social safety net have the effect of lowering inequality.  The shape of a possible Kuznets Curve is shown in the next diagram.

  • Trends over the last 30 years show income inequality increasing within countries and between them.
  • For emerging countries, inequality has risen in most countries – suggesting that many nations have been on the rising part of the curve. Of the BRIC countries and other leading developing countries, only Brazil has seen an eventual fall in measured income inequality. Partly this is the result of deliberate inclusive growth policies including the conditional cash transfer policy explained in our chapter on Brazil.

We can see from the table below the depth of the scale of income inequality in some low and low-middle income countries. In South Africa 84% of cumulative income is held by the richest 40% of the population whereas the poorest fifth take just 3 % of income.

Income Shares for the Population

Bangladesh

India

Sri Lanka

Congo

Kenya

South Africa

Nigeria

Income share held by lowest 20%

9

9

7

5

5

3

4

Income share held by second 20%

12

12

10

9

9

5

8

Income share held by third 20%

16

16

14

14

13

8

13

Income share held by fourth 20%

21

21

21

21

20

16

20

Income share held by highest 20%

41

42

48

51

53

68

54

Source: World Bank





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