Economic Growth and its Determinants

Meaning of Economic Growth

• Economic growth has been defined in two ways:

  • As a sustained annual increase in real national income (or Net National Product at constant prices) over a long period.

  • As a sustained annual increase in real per capita income/output over a long period.

• The definition of economic growth in terms of total national income has been criticized as inadequate because national income may rise while the standard of living declines if population growth exceeds national income growth.

• If national income grows at 1% per year while population grows at 2% per year, the standard of living tends to fall because per capita income declines; conversely, per capita income rises only when national income increases faster than population.

• Therefore, defining economic growth in terms of real per capita income is considered superior, since the primary objective of economic growth is to raise the standard of living of the people.

• According to Arthur Lewis, economic growth means the growth of output per head of population, emphasizing the importance of per capita output rather than aggregate output.

• A rise in national income or per capita income qualifies as economic growth only when it is a sustained increase; this implies a continuous upward trend over a long period, not a temporary increase.

• A short-term rise in per capita income, such as one occurring during a business cycle, cannot be regarded as genuine economic growth.

• Economic growth is commonly measured through both:

  • Increase in Gross National Product (GNP) or Net National Product (NNP).

  • Increase in real per capita income.

• GNP measures the total output of goods and services an economy can produce, whereas per capita income measures the average quantity of real goods and services available per person for consumption and investment, and thus reflects the average standard of living.

• International institutions such as the World Bank and International Monetary Fund (IMF) use both overall GNP/NNP growth and per capita income growth in their development reports to compare economic growth and living standards across countries.

• In India, institutions such as the Planning Commission, Central Statistical Organization (CSO), and Reserve Bank of India (RBI) also measure economic growth using both aggregate national income and per capita income indicators.

• Recent estimates indicate that developing countries have achieved higher economic growth rates than developed countries in recent years.

• However, over the past several decades, today’s developed countries experienced much higher growth rates while many developing countries remained relatively stagnant, resulting in significantly higher per capita incomes and living standards in developed economies.

• Consequently, the major challenge for developing countries is to catch up with developed countries by achieving rapid and sustained economic growth, thereby attaining higher levels of income and living standards.

Meaning of Economic Development : Traditional View

• In the early evolution of development economics, no distinction was made between economic growth and economic development, but since the 1970s a distinction has increasingly been considered necessary, though even the concept of economic development itself has been interpreted in different ways.

• The traditional view defines economic development as planned changes in the structure of national output, occupational distribution of labour, and the accompanying institutional and technological transformations; this interpretation is reflected in Simon Kuznets’s analysis of modern economic growth.

• According to this view, the development process involves:

  • A declining share of agriculture in both national income and employment.

  • Rising shares of industry and services in national income and employment.

  • Hence, development strategies until the 1970s largely emphasized rapid industrialization supported by suitable institutional and technological changes to achieve structural transformation.

• As stated by Charles P. Kindleberger, economic growth means an increase in output, whereas economic development means increased output along with changes in the technical and institutional arrangements through which output is produced; therefore, development = growth + structural change.

• Structural change refers to technological and institutional transformations that:

  • Shift labour from agriculture to modern manufacturing and services sectors.

  • Generate self-sustaining growth of output.

  • Move workers from low-productivity agricultural employment to higher-productivity industrial and service employment.

• During economic development:

  • The proportion of the labour force engaged in agriculture falls sharply.

  • Employment shares of industrial and service sectors rise substantially.

  • Agriculture’s percentage contribution to national income declines.

  • Industry and services contribute an increasing share to national income.

• These sectoral shifts occur because:

  • Economic growth and rising incomes alter the consumption pattern of people.

  • Productivity levels change across different sectors of the economy.

• Although factors such as literacy, education, and health were recognized as contributing to development, they were generally regarded as secondary factors rather than central drivers.

• Overall, the dominant pre-1970s perspective viewed development primarily as an economic phenomenon, assuming that gains from higher GNP/per capita GNP and accompanying structural changes would trickle down to the poor and unemployed.

• Consequently, this approach did not assign separate or special importance to:

  • Eliminating mass poverty.

  • Reducing unemployment.

  • Correcting income inequalities.