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Factors Affecting 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
24 Nov 2018 11:00
Factors Affecting Economic Growth
Shoran Devi

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 two per cent, this is sup­posed to mean that the economy has grown by two 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 recorded a growth of 3.0 per cent in 2017 and is forecast to achieve its ninth con­secutive year of expansion with a growth of 3.2 per cent, in 2018.

For 2019, the domestic economy is projected to achieve a broad based growth of 3.4 per cent.

In 2020 and 2021, the economy is expected to expand by 3.3 per cent, with major contributions expected from the wholesale and retail, con­struction, manufacturing and the financial and insurance sectors.

There are various other factors that can stimulate or negatively influence our domestic economic performance.

This include the external factors such as the demand from the rest of the world for Fijian products or services, natural disasters and prices of commodities such as oil, food etc.

In addition, non-quantifiable is­sues such as change in political environment affect business and consumer sentiments.

The continuity and consistency of policies has an important bear­ing on business decisions to invest or not.

Feedback: maraia.vula@fijisun.com.fj



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