What Is Economic Growth?

How It's Measured and What Are the Causes

Business group
Robust economic growth helps everyone in a society. Photo: Jon Feingersh/Getty Images

Definition: Economic growth is how much more the economy produces than it did in the prior period. To be accurate, the comparison must remove the effects of inflation.

If the economy is producing more, businesses are more profitable and stock prices rise. That gives companies capital to invest and hire more employees. As more jobs are created, incomes rise. Consumers have more money to buy additional products and services.

Purchases drive higher economic growth. For this reason, all countries want positive economic growth. This makes economic growth the most watched economic indicator.

How Is Economic Growth Measured?

Gross domestic product is the best way to measure economic growth. That's because it takes into account the country's entire economic output. It includes all goods and services that businesses in the country produce for sale. It doesn't matter whether they are sold domestically or overseas.

GDP measures final production. It doesn't include the parts that are manufactured to make a product. It includes exports because they are produced in the country. Imports are subtracted from economic growth. 

Most countries measure economic growth each quarter. They use real GDP to compensate for the effects of inflation. Here's more on the GDP growth rate and how you can calculate it.

GDP doesn't include unpaid services.

It leaves out child care, unpaid volunteer work or illegal black-market activities. It doesn't count the environmental costs. For example, the price of plastic is cheap because it doesn't include the cost of disposal.  As a result, GDP doesn't measure how these costs impact the well-being of society.

A country will improve its standard of living when it factors in environmental costs. A society only measures what it values.  

Similarly, societies only value what they measure. For example, Nordic countries rank high in the World Economic Forum's Global Competitiveness Report. That's because their budgets focus on the drivers of economic growth. These are world-class education, social programs and a high standard of living. These factors create a skilled and motivated workforce. These countries have a high tax rate. But they use the revenues to invest in long-term economic growth. For more, see Riane Eisler's book, The Real Wealth of Nations.

This economic policy contrasts with that of the United States. The country uses debt to finance short-term growth through boosting consumer and military spending. That's because these activities do show up in GDP. 

The Phases of Economic Growth

Analysts watch economic growth to discover what stage of the business cycle the economy is in. The best phase is expansion. This is when the economy is growing in a sustainable fashion. If growth is too far beyond a healthy growth rate, it overheats. That creates an asset bubble. This is what happened to the housing sector in 2005-2006.

As too much money chases too few goods and services, inflation kicks in. This is the "peak" phase in the business cycle.

At some point, confidence in economic growth dissipates. When more people sell than buy, the economy contracts. When that phase of the business cycle continues, it becomes a recession. An economic depression is a recession that lasts for a decade. The only time this happened was during the Great Depression of 1929.

Causes of U.S. Growth

The United States has an abundance of natural resources. Its large land mass compares to Russia, Canada and Australia. America's natural resources also include:

  • Tillable soil in the Great Plains, called the breadbasket of the world.
  • A temperate climate.
  • Large deposits of oil, coal and natural gas.

These natural resources attracted another of America's great resources which is its population.

The United States has a large and diverse population that provides a large test market. It gives domestic companies experience in knowing what consumers want. This has given the United States a comparative advantage in producing consumer products. As a result, over 70 percent of what the country produces is for personal consumption.

This also gives U.S. companies an advantage in exporting. As a result, the United States is the world's fourth largest exporter.  The country exports capital equipment, such as computers, semiconductors and medical equipment. It also exports industrial machinery and equipment such as plastics, chemicals and petroleum products. Almost half of the economy depends on services. The most successful are financial services, and healthcare and intellectual property such as technical information.

Ways to Spur Economic Growth

Most governments try to manage economic growth. For one thing, growth increases tax revenue. Businesses also hire workers, increasing income. When people feel prosperous, they reward political leaders by re-electing them.

The government stimulates growth with expansive fiscal policy. It either spends more, cuts taxes or both. Since politicians want to get re-elected, they use expansive fiscal policy to stimulate the economy.

Expansive fiscal policy is addictive. If the government keeps spending more and taxing less, it leads to deficit spending. It works for a while, but eventually leads to higher debt levels.

In time, as the debt to GDP ratio approaches 100 percent, it slows economic growth. Foreign investors stop investing funds in a country with a high debt ratio. They worry they won't get repaid or that the money will be worth less.

Therefore, governments should be careful with expansive fiscal policy. They should only use it when the economy is in contraction or recession. When the economy is growing, its leaders should cut back spending and raise taxes. This conservative fiscal policy ensures that the economic growth will remain sustainable.