Drivers of Economic Growth 101
The most dynamic economic change tends to occur when the state creates an institutional environment that provides an incentive for the creation of ideas; technologies and innovations while encouraging entrepreneurship, trade and competition. With many countries around the world hoping for an economic comeback from a slowing economy which has been exacerbated by the Covid-19 pandemic, here’s a brief overview of some of the drivers of economic growth:
1. Science and Technology
The Romer model shows that the creation of new ideas through Research and Development (R&D) results in technological progress thus high levels of output and utility can to a certain extent be determined by the size and productiveness of R&D. In the long run, capital exhibits diminishing returns thus economic growth can be attributed to technology. Technology and innovation bring about new ways of doing things, making capital and labour more efficient and productive thereby allowing for more to be done with limited resources. The higher the level of scientific knowledge, the lower the cost of invention and thus the higher the level of innovation and ultimately economic growth.
There are two interdependent types of technology which co-evolve to drive economic growth; physical technologies which increase capacity for more production and social technologies (institutions) which support and provide an incentive for the creation of physical technologies. Per the Nelsons (2002), new social technologies; often come into the picture as new ways of organising work, new kinds of markets, new laws and new forms of collective action—that are called for as the new technologies are brought into economic use. Economic performance depends on how a country’s institutions manage to adapt and advance technology.
Institutions in the form of stricter property rights and patent laws provide an incentive to innovate given they lower the discount rate as ideas are non-rivalrous and to a great extent non-excludable thus generating spill-overs. Institutions result in a temporary monopoly for innovators allowing them to make a profit but because the social return to innovation is higher than the private return even to a monopolist, it is important that governments finance research as the market alone does not provide enough incentives. Countries in which governments finance research tend to develop faster than others. Policies that open up the market for new innovators and reduce red tape would also encourage creative distraction.
2. The State
States need to be capable; create rules that ensure predictability, encourage future investment and be cooperative whereby they avoid hostile competition between state and business. Stable and effective bureaucracies encourage economic agents to make long term investments as government policies are predictable which in turn makes planning of public infrastructure more effective. Bureaucratic competence leads to economic growth as it increases legitimacy which helps entrepreneurs coordinate business activities, take on risks and move into export markets competing with others.
Empirical evidence suggests that economic growth reduces poverty. This is because the state can spend more on social protection which reduces capability poverty. For example, investment in health or medicine reduces ill health which is important for growth per the Romer growth model as an improvement in health and life expectancy not only increases the labour force but increases the number of researchers which leads to an increase in the quantity and to a certain extent the quality of ideas thereby increasing economic growth through technological improvement. This is however holding all things constant as a rapid increase in population growth might reduce the investment in human capital which is pivotal for growth thereby causing a drag in economic growth.
Weber argues that states are effective due to the emergence of rationality which leads to new social relations and institutions. He says:
“... bureaucratically structured organisations, using their own distinct set of decision- making procedures, are a necessary complement to market-based institutions ... public administrative organisations characterized by meritocratic recruitment and predictable, long-term career rewards, will be more effective at facilitating capitalist growth than other forms of state organisation” (Weber, 1968)
Meritocratic recruitment means the best person is hired for the job increasing efficiency and effectiveness. This coupled with competitive wages as in the private sector will create a virtuous spiral encouraging competent people to join them thus making corrupt practices less likely and the costs of being found out very high; creating an environment for dynamic economic change (Henderson et. al, 2007).
The state can also drive economic change by creating a stable economic environment conducive for competition by reducing diversion in the form of excessive taxation, red tape and corruption. Countries with a good social infrastructure attract more investments and have high total factor productivity. This leads to trade and globalisation which are major contributors to development. The Chinese industrial parks provide a good case study for competition as local authorities in order to attract capital investment would provide civic amenities, internet and telephone infrastructure, land as well as a friendly business environment knowing that firms gravitate towards such conditions and once they move in, there would be job creation, development of the local economy and the region would receive tax revenue.
While I have focused on the roles science and technology as well as the state play in driving economic growth, there are many other drivers that have led to high levels of GDP in various countries.
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