There are two meanings of the term economic growth : actual growth and potential growth. Actual growth is an increase in real incomes or Gross Domestic Product (GDP); and potential growth is an increase in the productive capacity of a country. If economic growth is measured using national income, then the value is meaningless unless the figures are given in real rather than nominal terms. Real values have been adjusted to remove the effects of inflation, whereas nominal values are the current incomes that you wold see if they were unadjusted.
Furthermore, for GDP to have any significance in terms of standards of living, figures must be given per head (or ‘per capita’). If a country’s income increases by 10%, but the population increases by 20%, people are actually worse off per head.
Another important distinction required when measuring economic growth is to look at values rather than volumes. Firms might achieve higher sales figures because they sell more in volume or number of products, but if those sales are worth less per unit then they are not in fact seeing an increase in the value of their output. As an example, consider Germany and China. Germany is the biggest exporter in the world by value, whereas China is the biggest by volume.
How is GDP measured?
Gross domestic product is the sum of all goods and services produced in a country in 1 year. It is also the sum of all incomes earned in 1 year, and the sum of all expenditure in one country in 1 year. Consider it as a circular flow of income where for everything that is earned, something must be produced and something must be spent. The government measures these three flows: goods, income and expenditure, which in theory should amount to the same figure (currently around 1.4 trillion in the UK). However, in practice, errors and omissions mean that there a some discrepancies.
Increases in GDP are therefore a sign that a country is experiencing increasing incomes, output and spending. On the face of it, this is a good thing because people can have more goods and services, implying that they may have a better standard of living. However, there are many reasons why this might not be the case. If I earn more, it may be that I work longer hours and have more work pressures, or that I have a higher cost of living, such as increased mortgage payments. Pollution is likely to increase as I travel more miles, and there are a whole range of social costs that may be incurred.
Standards of living therefore include factors besides economic growth, although few believe that economic growth has no part to play in increasing living standards.
Problems of comparison
Lets say that growth is 10% in China, 6% in Bangladesh, and around 2% in the UK. These figures mask several differences that are not accounted for in GDP statistics:
- Subsistence, barter and the black economy. If farmers consume their own output, if goods are traded without the price system, or if goods are paid for without being declared for tax purposes, then national income will not reflect the true standard of living.
- Currency values. When trying to compare countries, there is a difficulty in knowing wether to use the official value of a currency of the purchasing power of that currency.
- Income distribution. When comparing countries income per head, some sense of the income distribution should also be taken into account. In some ases, a large proportion of income is earned by very few, which makes the mean income much higher than the income enjoyed by an ordinary person. In this way the general standard of living in a country can appear higher than it really is for most people.
- Size of the public sector. If much of the spending in the economy in the economy is by government, it might or might not improve welfare of the population.
- Jam today or jam tomorrow? Spending on investment foods might mean standard of living increases in the future, by at the expense of living standards today. It is better to take account of future growth patterns rather than simply considering today’s income, and stark economic growth figures should be broken down to look at the investment element.
- Quality issues. Spending on schools might be high, for example, but how an we measure quality? Are improving results enough to reach a conclusion that standards of living are improving?
These problems in comparing GDP figures between countries and over time mean that comparisons of living standards are likely to be inaccurate if they are based solely on GDP. However, real income growth per head is a good guide tif these other factors can be taken into account.