Factors That Determine Economic Growth

Written by shane hall
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Factors That Determine Economic Growth
Inflation, including high energy prices, can stifle economic growth. (altrendo images/Stockbyte/Getty Images)

Economists often measure economic growth by inflation-adjusted increases in a nation's gross domestic product (GDP), the aggregate measure of economic activity. An alternate measure is the rate of increase in personal incomes, measured by per capita GDP. Rates of economic growth vary across nations, causing many economists to ask what factors contribute to that growth. Knowing what factors determine economic growth helps explain the differences in prosperity that exist across nations.

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Price Stability

A stable price system that holds inflation to a minimum facilitates the kind of decision making that generates economic growth. Dr. Stephan Pfeffenzeller, a lecturer in economics at the University of Liverpool, points out that stable prices help guide production and investment decisions. Maintaining low inflation requires strong monetary policy that operates independently of political pressure and strives to contain inflationary pressures, thus fostering stable rates of growth.

International Trade and Investment

Economic globalisation is a modern-day reality, with goods and investment capital flowing across borders at unprecedented levels. Free trade agreements and entities such as the North American Free Trade Agreement and the World Trade Organization have fuelled the growth of this global economy. Pfeffenzeller argues that a nation's openness to international trade and foreign investment promotes growth. Increased exports contribute to higher productivity, Pfeffenzeller writes, citing post-World War II Germany as an example.

Entrepreneurship

Writing in the Concise Encyclopedia of Economics, economist Paul Romer points out that growth occurs when someone takes resources, such as land, labour and capital, and rearranges them in a way that makes them more valuable. This observation highlights the importance of entrepreneurship in driving economic growth. Entrepreneurs often introduce new technologies and other innovations that displace old ways of doing business. Austrian-born economist Joseph A. Schumpeter wrote in the early 20th century of the importance of entrepreneurs in "The Theory of Economic Development."

Sound Economic Policy

A stable economic environment that fosters growth requires sound government. Economists since Adam Smith in the 18th century have recognised the need for government to protect property rights and enforce a system of contracts that guards against fraudulent transactions in the marketplace. Pfeffenzeller cautions that government should assume a balanced role in its stewardship of a nation's economy, noting that excessive regulation and other intrusion poses unnecessary costs on business, stifling economic activity. Rather, governments should employ a level of regulation that protects the economy from reckless business activity.

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