For example, the United Kingdom experienced a 1.97% average annual increase in its inflation-adjusted GDP between 1830 and 2008. In 1830, the GDP was 41,373 million pounds. It grew to 1,330,088 million pounds by 2008. A growth rate that averaged 1.97% over 178 years resulted in a 32-fold increase in GDP by 2008.
The large impact of a relatively small growth rate over a long period of time is due to the power of exponential growth. The rule of 72, a mathematical result, states that if something grows at the rate of x% per year, then its level will double every 72/x years. For example, a growth rate of 2.5% per annum leads to a doubling of the GDP within 28.8 years, whilst a growth rate of 8% per year leads to a doubling of GDP within 9 years. Thus, a small difference in economic growth rates between countries can result in very different standards of living for their populations if this small difference continues for many years.
Quality of life
One theory that relates economic growth with quality of life is the "Threshold Hypothesis", which states that economic growth up to a point brings with it an increase in quality of life. But at that point – called the threshold point – further economic growth can bring with it a deterioration in quality of life. This results in an upside-down-U-shaped curve, where the vertex of the curve represents the level of growth that should be targeted. Happiness has been shown to increase with a higher GDP per capita, at least up to a level of $15,000 per person.
Economic growth has the indirect potential to alleviate poverty, as a result of a simultaneous increase in employment opportunities and increased labor productivity. A study by researchers at the Overseas Development Institute (ODI) of 24 countries that experienced growth found that in 18 cases, poverty was alleviated.
In some instances, quality of life factors such as healthcare outcomes and educational attainment, as well as social and political liberties, do not improve as economic growth occurs.
Productivity increases do not always lead to increased wages, as can be seen in the United States, where the gap between productivity and wages has been rising since the 1980s.
Business cycle
Economists distinguish between short-run economic changes in production and long-run economic growth. Short-run variation in economic growth is termed the business cycle. Generally, economists attribute the ups and downs in the business cycle to fluctuations in aggregate demand. In contrast, economic growth is concerned with the long-run trend in production due to structural causes such as technological growth and factor accumulation.
Income equality
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Further information: Economic inequality
Some theories developed in the 1970s suggested possible avenues through which inequality may have a positive effect on economic development. Savings by the wealthy, if these increase with inequality, were thought to offset reduced consumer demand.
Later analysis, such as the political economy approach, developed by Alesina and Rodrik (1994) and Persson and Tabellini (1994), stressed the negative impacts of inequality on economic development; inequality generates a pressure to adopt redistributive policies that have an adverse effect on investment and economic growth. However, empirical tests of an extended version of Alesina and Rodrik's model by Li and Zou found that "income inequality is positively, and most of the time significantly, associated with economic growth".
The credit market imperfection approach, developed by Galor and Zeira (1993), argued that inequality in the presence of credit market imperfections has a long lasting detrimental effect on human capital formation and economic development.
A study by Perotti (1996) showed that in accordance with the credit market imperfection approach, inequality is associated with lower level of human capital formation (education, experience, apprenticeship) and higher level of fertility, while lower level of human capital is associated with lower growth and lower levels of economic growth. In contrast, his examination of the political economy channel found no support for the political economy mechanism.
A 1999 review stated that high inequality lowers growth, perhaps because it increases social and political instability; however, changes in the degree of inequality have a relatively minor effect on growth.
Research by Robert Barro, found that there is "little overall relation between income inequality and rates of growth and investment". According to Barro, high levels of inequality reduce growth in relatively poor countries but encourage growth in richer countries. Princeton economist Roland Benabou's research shows that inequality does not matter per se to growth, but "inequality in the relative distribution of earnings and political power" does matter.[citation needed]
According to Andrew Berg and Jonathan Ostry (2011) of the International Monetary Fund, inequality in wealth and income is negatively correlated with subsequent economic growth. Likewise, economists Dierk Herzer and Sebastian Vollmer found that increased income inequality reduces economic growth, but growth itself also increases income inequality in the long run.
In 2013, French economist Thomas Piketty postulated that in periods when the average annual rate on return on investment in capital (r) exceeds the average annual growth in economic output (g), the rate of inequality will increase.[110] According to Piketty, this is the case because wealth that is already held or inherited, which is expected to grow at the rate r, will grow at a rate faster than wealth accumulated through labor, which is more closely tied to g. An advocate of reducing inequality levels, Piketty suggests levying a global wealth tax in order to reduce the divergence in wealth caused by inequality.
Equitable growth
While acknowledging the central role economic growth can potentially play in human development, poverty reduction and the achievement of the Millennium Development Goals, it is becoming widely understood amongst the development community that special efforts must be made to ensure poorer sections of society are able to participate in economic growth. The effect of economic growth on poverty reduction – the growth elasticity of poverty – can depend on the existing level of inequality. For instance, with low inequality a country with a growth rate of 2% per head and 40% of its population living in poverty, can halve poverty in ten years, but a country with high inequality would take nearly 60 years to achieve the same reduction. In the words of the Secretary General of the United Nations Ban Ki-Moon: "While economic growth is necessary, it is not sufficient for progress on reducing poverty."
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