Drivers of Economic Growth

8/7/2019 Drivers of Economic Growth

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Q&A : Drivers of economic grow th

28 Apr 2009

Economic growth is essential to all consumer markets as it is usually accompanied by an increase in employment and standard

of living. This in turn is reflected by growing consumer incomes and higher expenditure. As consumer markets develop in line w

economic growth, patterns of consumer spending also change as there is a higher portion of income available for discretionary

spending. This Q&A examines the factors that drive economic growth. Where these factors converge, income and expenditure

be expected to grow.

What are the key drivers of economic growth?1. Productivity

2. Employment rates

3. Technology gains

4. Education and innovation

5. Business environment

6. Foreign direct investment (FDI)

7. Population growth

8. Infrastructure

9. Foreign trade

10. Macroeconomic policies

1. Productivity

A measure of output compared to input. Labour productivity is the most widely used measure and is calculated by GDP per

person employed or GDP per hour worked. Productivity gives an indication of the efficiency and competitiveness of an econom

Raising labour productivity drives economic growth, increases wages and encourages inward investment, in turn creating a

competitive business environment and better standards of living. The USA is often cited as one of the most productive countrie

the world and in 2008 its labour productivity per person employed was 41.8% higher than the EU-27 average.

2. Employment ra tes

Employment rates (calculated by dividing the number of persons aged 15 to 64 in employment by the total population of the sa

age group) provide information on the ability of an economy to create jobs and are an indication of the potential room for grow

Increasing labour input through the number of employed people (or hours worked) will increase economic growth and output.

Scandinavian countries such as Denmark and Sweden have achieved high employment rates at 78.6% in Denmark in Q3 2008

and 75.7% in Sweden, compared to an EU-27 average of 66.4%. However, there is more potential in a less developed country

such as Turkey where the employment rate in Q3 2008 was just 47.7%. One of the main reasons for low employment in Turke

the low participation of women where the female employment rate in the same period was 25.8%. Increasing female participat

in Turkey will increase the numbers in the labour force and rapidly contribute to higher economic growth.

3. Technology gains

Technology drives productivity growth through gains in efficiency. The USA performed better than Western Europe in the ninetidue to its adoption of technology. Between 1990 and 2000, US average annual economic growth was 3.2% compared to 2.4%

year in the UK. As emerging economies develop their IT infrastructure and increase access to computers and high-tech produc

economic growth will also be accompanied by an increase in productivity. The link between technology and productivity can be

further exemplified by countries which are still catching up on technology infrastructure. Bulgaria, for example, had a broadban

penetration rate (broadband access lines per 100 inhabitants) of just 9.5 in 2008 (compared to an EU-27 average of 21.7). Its

labour productivity per person employed was just 36.2% of the EU-27 average in 2008.

4. Education and innovation

Education can be a critical factor in determining the level of economic development and business environment of a country. Lo

standards of education will limit local skill levels, hold back incomes and affect the competitiveness of a country. Better educat

leads to a skilled workforce and high-tech economies. Short-term boosts to the labour market can also be achieved thorough

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training to upgrade skills, which will improve human capital.

Better education will in turn also contribute to increasing innovation. Innovation contributes to investment, human capital and

productivity. Research and development expenditure (R&D) is an investment in knowledge and will enable economies to move

the value added chain. R&D by the business sector is believed to show the highest returns. The EU has a target for R&D of 3%

GDP by 2010.

5. Business environment

An attractive business environment will increase FDI, economic growth and productivity. Less regulation and corruption can als

help economic growth. The USA started deregulating earlier than its Western European counterparts, which is why some consid

its business environment to be better. The US business environment is ranked third out of 181 countries in the World Bank Eas

of Doing Business index 2009 and ranked top for employing workers. In contrast, some major emerging economies are beingheld back by a lack of reform. State control remains a problem in China and Russia, whereas rigid labour regulations in Japan

create problems there. China ranked 83 out of 181 countries in the 2009 Doing Business rankings while Russia ranked 120.

6. Foreign direct investment (FDI )

FDI inflows directly help economic growth by creating jobs and stimulating the business environment. FDI is also important to

transfer technological knowledge and know-how, and increase productivity. While developed countries remain the leaders in FD

inflows in nominal terms, with US$232,865 million in the USA in 2007; in terms of the importance to GDP developing countries

dominate. For example, in the USA, FDI inflows amounted to just 1.7% of GDP in the same year, but inflows accounted for 21.

of GDP in 2007 in Bulgaria (following EU accession) or as high as 35% in some Caribbean islands.

7. Population growth

Population growth can drive the economy by directly adding to the labour pool and increasing the future market of consumers.

However, population growth must also be matched by economic growth to improve standards of living. An economy must have

the ability to create enough jobs for the population or unemployment, falling living standards and social tension may arise.

Many industrialised countries are facing ageing populations. In Japan, the median age of the population was 45.3 in 2008, much

higher than its regional counterparts such as 27.5 in Indonesia. This is reducing the potential labour force while also putting a

burden on the working age population, which has to support the elderly and their pensions.

In Eastern Europe, populations are not only declining due to westward migration but high rates of male mortality and lower

fertility rates are creating the problem of populations shrinking, which has a flow-on effect on the labour force. In Russia, the to

population is expected to decline by 3.7% between 2008 and 2020 with the working age population (15-64) is expected to

contract by 8.3%; this will exert downward pressure on economic growth in the future.

8. InfrastructureInvestment in infrastructure projects (transport, telecoms, IT etc.) not only helps boost short-term growth by creating jobs and

providing business opportunities but the gains are also felt in the longer-term. Improved transport infrastructure, for example,

narrow regional inequalities as well as reducing commuter times and helping the mobility of the labour force. Colombia's

economic and geographical features, for example, mean that it has complex logistics needs. Its main cities and industrial zone

are located in the country's interior, at lengthy distances from the main ports, making it reliant on road and multi-modal

transport. However, just 15% of roads were paved in 2008 making investment in infrastructure a priority. The government has

developed a comprehensive plan for the transport and logistics sector to 2019. Meanwhile, access to the Internet can also redu

regional inequalities. The wider use of the Internet helps facilitate e-government, boost international trade, while companies en

quicker and paperless administration.

9. Foreign trade

Foreign trade boosts GDP and generates foreign currency earnings. At times of economic growth, imports also increase asconsumer incomes improve and demand grows. The OECD estimates that an increase of 10 percentage points in trade exposu

(in percentage of GDP) could lead to an increase in output per working age person of 4%. Trade is more important in some

countries as a driver of economic growth than others. China's rapid economic growth since 2003, for example, can be attribute

to a significant increase in exports. Exports in China accounted for 26.7% of GDP in 2003 and increased to 34.2% by 2008. Yet

over-reliance on foreign trade can leave an economy vulnerable to external shocks - in Japan, for example, real GDP contract

by 3.2% in Q4 2008 from the previous quarter particularly owing to slumps in automotives and electronic exports.

10. Macroeconomic policies

Macroeconomic policies can also contribute to economic growth. This is particularly evident during times of economic downturn

when governments and central banks act to try and boost economic growth. Lower inflation, for example, usually encourages

economic growth and consumer spending, so interest rates are cut. High taxes on the other hand can reduce growth potential.

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The OECD estimates that a one percentage point increase in the overall tax rate (in percentage of GDP) will reduce output per

working age person by around 0.6-0.7%, while a fall of one percentage point in the inflation rate will increase output per worki

age person by 0.4-0.5%.

Keywords

Bulgaria, China, Colombia, Denmark, Eastern Europe, Indonesia, Japan, Russia, Sweden, Turkey, United Kingdom, USA, WesternEurope, World | Total GDP, Real GDP growth, Business environment, Foreign direct investment inflows, Population: nationalestimates at January 1st, Median age of population, Births, Deaths, Transport, Exports

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