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Factors Affecting Economic Growth

This is an informative publication, sponsored by The Fiji Sun, Fiji Bureau of Statistics and HFC Bank. All views expressed or implied are purely of the Financial Markets Analyst at
01 Jul 2017 10:00
Factors Affecting Economic Growth

This is an informative publication, sponsored by The Fiji Sun, Fiji Bureau of Statistics and HFC Bank. All views expressed or implied are purely of the Financial Markets Analyst at the HFC Bank, Shoran Devi.

 

In the midst of budget announcements and related discussions, it is noteworthy to mention some of the key drivers of economic growth.

Economic growth is an increase in real Gross Domestic Product (GDP).

It represents the total dollar value of goods and services produced in an economy over a specific time period adjusted for any price movements.

The rate of economic growth is the annual percentage increase in real GDP and is expressed as a comparison to the previous quarter or year. For example, if the year-to-year GDP is up 2 per cent, this is supposed to mean that the economy has grown by 2 per cent over the last year.

While there are several factors affecting economic growth, it is convenient to split them up into two broad categories:

Demand side factors (e.g. consumer spending)

Supply side factors (e.g. productive capacity)

 

In the expenditure approach to calculating GDP, the demand side factors are captured by Aggregate Demand and is composed of Consumption, Investment, Government spending and Exports. A rise in Consumption, Investment, Government spending or Exports can lead to higher Aggregate Demand and hence higher economic growth.

 

What factors influence aggregate demand?

  • Interest rates.

Interest rates are the cost of borrowing or the reward for saving money.

It affects peoples’ decisions on whether to save or spend their money.

Usually if the interest rate is high, people tend to delay their consumption and save more to earn a higher return.

Similarly, high interest rates often leads to reduced borrowing as the cost of borrowing increases.

In times of lower interest rates, there is more borrowing as the cost of borrowing would be reduced and less saving due to less return.

This increased borrowing and reduced savings would result in increased spending and hence boosts economic activity.

The decisions by savers and borrowers affect consumption and investment decisions, and ultimately aggregate demand and overall economic activity.

  • Value of exchange rate.

The exchange rates have a direct relation to the nation’s trade deficit.

While many of us may disdain a weaker domestic currency because it makes cross-border shopping and overseas travel more expensive, a weaker currency would normally stimulate exports and discourage imports, thereby decreasing a nation’s trade deficit (or increasing surplus) over time.

Of the many other factors, a stable exchange rate system also attracts foreign investments which provides essential ingredients that are necessary for economic growth.

  • Consumer confidence.

Consumer confidence reflects the consumers’ perception about the overall state of the economy and their expectations for future.

It determines the willingness of consumers to spend, borrow and save and is used as an indicator of the overall state of the economy.

A strong consumer confidence indicates a rise in consumer spending and hence increase in economic activities.

  • Real balances.

Real balance/income reflects the purchasing power of a given amount of money in circulation.

Real income is affected by the price levels (inflation).

When prices fall, the purchasing power of the currency goes up and people are able to purchase more goods and services from their same level of income which in turn impacts the level of aggregate demand and consequently the level of economic activity.

 

In the long run, the increase in aggregate demand alone will be seen as inflationary unless there is increase in aggregate supply.

Therefore, the long run aggregate supply should increase with the rise in aggregate demand leading to an increase in economic growth without inflation.

The supply side of the economy reflects the willingness and ability of producers to supply GDP.

 

Key factors that influences a country’s supply-side potential:

  • Human capital.

Increased labour market participation and improvements in productivity and efficiency of the labour force directly impacts the production capacity of the economy.

This in part is affected by improved work incentives, investment in capacity building of the labour market through better education and training and through improved mobility of the labour force. Increased strength of the labour market results in increase in output and so impacts the growth potential of an economy.

  • Development of technology.

Technological advancement has been one of the key reasons, if not THE key reason, that the modern economy has achieved current, historically unprecedented, living standards.

Technological advancements allows suppliers to produce more goods at cheaper cost.

This leads to increase in production capacity and hence increase in aggregate supply.

  • Levels of infrastructure.

Investment in roads, transport networks and communication can help firms reduce costs and increases the potential output of an economy. Infrastructure development is considered as a complementary factor for economic growth.

Other factors that may affect growth in the short term are weather, commodity prices and political stability.

The Fijian economy has grown remarkably and despite the adverse effects of Tropical Cyclone Winston and the floods in 2016, the economy is estimated to have grown by 2.0 percent.

The damage from TC Winston was estimated to equal 28 per cent of GDP, with agriculture and forestry the hardest hit.Capture

For 2017, the domestic economy is projected to record a growth of 3.8 percent, slightly higher than the earlier forecast of 3.6 percent.

The years 2018 and 2019 also look promising with the economy projected to grow by three per cent, and if achieved, Fiji will register 10 years of consecutive economic growth, the longest period of sustained economic growth since Independence.

 

 

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