This paper analyzes the factors that determine the long run economic growth and how each factor affects the income growth of per-capita of a country. For this paper, economic growth is taken to mean an increase in a country’s standard of living over a given period. Factors relating to economic growth in the long-run basically focus on those factors which are measured due to the change in per-capita Gross Domestic Product (GDP). Various approaches can be used to explain these factors, for instance, the production function approach. Basically, it organizes the growth in terms of as an aggregate production function. Production function shows how a country’s output per worker y, depends on each worker’s stocks of physical, human, and natural capital, k. Thus, the following factors relate to the factors that affect economic growth in the long-run.
Rate of capital accumulation and investment
There are different types of capital that that correlates directly to the rate of long run economic growth. Capital is classified as physical, human, and or natural capital. Physical capital comprises of tools, machines, infrastructure, machines and buildings. They are produced through investment and are used majorly in producing output. Variations in physical capital tamper with the level of investment. An economy not open to external capital flows have its investment rate same to its savings rate. Hence, the rate at which an economy invests in physical capital determines its positive economic growth in the long run. Similarly, the rate of accumulation of the other factors of production produces differences in level of physical capital per worker thus determining the rate of growth in the long run.
Human capital on the other hand is such factors as quality of education and health that allow a worker to produce more output and which themselves are the results of past investment. Like physical capital, human capital earns an economic return for its owner. Thus in the long run, individuals with high quality services will definitely have a higher per-capita income.
Natural capital is the value of a country’s agricultural and postural lands, forests and subsoil resources. They are inputs into the production of goods and services. Natural capital per worker correlates positively to the GDP per worker. As country becomes productive in natural capital, its per-capita income is bound to increase. Thus, capital accumulation and investment in physical, human and natural resources make a country grow faster hence an increase in economic growth in the long run. Lack of access to these forms of capital locks an productivity hence lower per-capita income.
Size of Population
Population affects the accumulation of the forms of capital mentioned. Drastic increase in population dilutes the quantity of both the physical and human capital per worker thereby increasing the rate of investment and education expenses to help balance output per worker. Exponential growth in population lowers output per capital for the case of natural capital. Together with a positive result from the level of income to population growth, this resource constraint results in a stable steady state level of output per capital (Aghion et al, 1992).
Apart from its effect on the level of factors of production per worker, population is as well of concern with long run economic growth due to its demographic change that consequently result in the variation of age structure of the population over time. For instance, a mere decrease in fertility rate has consequent impact of decreased dependency ratio. Besides this, an increase in population of age working group leads to an economy’s savings rate. Higher savings rate in return increases the investment rate. Investment prompts economic growth thus an increase in per capita income (Aghion et al, 1992)
Level of productivity
Productivity is defined as measure of the degree of output from the process of production per unit of input. Labour productivity is for instance gauged on ratio of output per labour hour. Growth in level of productivity implies that more value is added in production hence more income is in place to be distributed to the population which leads to a higher per-capita income in the long run hence economic growth (Acemoglu et al 2001).
Stability in inflation
Advantageous economic decisions stem from a stable general economic environment. Stable inflationary environment is of weight to an economic growth in the long run. Substantial changes in inflation rate are more dangerous since it is never easy to predict. Basically, relative prices of products act as a guideline to investment decisions. If there are shifts in relative value of goods due to inflationary pressures, investment and production may be redirected into less profitable activities. In the long run these misallocated activities definitely lead to a decrease in growth of both human and natural capital as compared to what could have been achieved under balanced resource allocation. The misallocation in investment and production thus result in a decrease in economic growth per-capita in the long run.
“The Dutch Disease”
Dutch disease is the deindustrialization of a nation’s economy. It takes place as a result of an increase in the value of a country’s currency due to a breakthrough in a natural capital allocation. This makes the manufactured goods less competitive as when compared to other nations thereby resulting in an increase in imports and decrease in exports. It is the recession that hits other sectors when one industry dominates, or increases its exports. Since the value of the currency rises, manufacturing sectors no longer remain competitive, leading to a slump in the manufacturing sector.
Nigeria is a developing country that that is believed to be undergoing the ‘Dutch Disease’. With well endowed oil as the natural resource, the country’s economy has failed to go passed an excess capacity situation.
According to Mundell-Fleming model, the Dutch Disease’ economy can be analyzed in two categories: either by analyzing the goods and service sector or by analyzing the markets’ assets sector. For the goods and service sector, such factors like consumption and investment do affect the level of economic growth. However, consumption rate is affected by factors like the level of income. When the autonomous consumption is high, consumption on spending is negatively affected and thus the fraction of marginal propensity to consume is higher as opposed to a reduced marginal propensity to save.
Secondly, the model stresses on investment spending. Factors like higher interest rate that affects the investor wealth and confidence, also known as the autonomous investment do influence the level of spending investment spending on human capital or the physical capital. Basically, in situations where it is low, the economy stagnates without a distinctive growth in its GDP.
Also, as the domestic income increases, the residents spend more and mostly on imported goods and thus affecting adversely the demand for domestic goods. There is general increase in demand for foreign goods.
Why a rising U.S. budget deficit is associated with a growing current account balance deficit.
First, there is the saving glut or imbalance. This scenario is inconsistent with smooth adjustment to global imbalances. At the same time, as the rate at which the economy undertakes tax reforms is questionable. While there is little about incremental taxation reforms, changes may raise household saving and hence the more promising current policy. However, it demands fundamental tax reform. This is moving the U.S. tax systems to a broadbased income tax or consumption tax (Chinn et al, 2003).
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