What Is Economic Growth?

How It's Measured and What Are the Causes

economic growth
Economic growth is fueled by the auto and oil industries in the United States. Photo: Paul Zhang/Getty Images

Definition: Economic growth is how much more the economy produces than it did before. 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, driving higher economic growth. For this reason, all countries want positive economic growth.

That makes economic growth the most watched economic indicator.

How Is Economic Growth Measured?

Economic growth is measured by changes in the gross domestic product (GDP). It measures a country's entire economic output for the past year. That takes into account all goods and services that are produced in this country for sale, whether they are sold domestically or sold overseas. It only measures final production, so that the parts manufactured to make a product are not counted. Exports are counted because they are produced in this country. Imports are subtracted from economic growth. Economic growth is measured quarterly measured using real GDP to compensate for the effects of inflation. Here's more on the GDP growth rate and how you can calculate it.

Measurements of economic growth do not include unpaid services. They include the care of one's children, unpaid volunteer work, or illegal black-market activities.

They also don't include 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. The true standard of living will be raised when these components are measured.

Only when something is measured does it become important.

That's how the measurement itself can lower growth. For example, Nordic countries rank high in the World Economic Forum's Global Competitiveness Report.  According to Riane Eisler's book, The Real Wealth of Nations, that's because their fiscal budget focuses on the actual drivers of economic growth: world-class education, social programs that provide real value, and a high standard of living. That results in a high-skilled and motivated workforce. Yes, these countries have a high tax rate. But, they use the revenues to invest in long-term economic growth. 

That contrasts with the United States. It uses debt to finance short-term growth through boosting consumer and military spending. That's because these activities do show up in economic growth measurements. 

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, when the economy is growing sustainably. If growth is too far beyond a healthy growth rate, it overheats and creates an asset bubble. That's what happened in 2005-2006 with housing. As too much money chases too few goods and services, inflation kicks in.

That is usually 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.

What Drives U.S. Growth?

The United States is blessed with an abundance of natural resources. It also has a large land mass, comparable only to Russia, Canada, and Australia. These resources include:

  • Tillable soil in the Great Plains, known as 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 -- its diverse 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. That's given the U.S. a comparative advantage in producing consumer products. As a result, over 70% of what the U.S. 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 U.S. 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, healthcare and intellectual property, such as technical information.

Ways to Spur Economic Growth

Most governments try to manage economic growth. For one thing, when the economy is growing, businesses make more money, which increases tax revenue. They also hire more people, which increases income. When people feel prosperous, they reward political leaders by re-electing them.

The government can stimulate the economy through expansive fiscal policy. That's when 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 to spur economic growth, 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%, it can slow economic growth. Foreign investors may 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. It 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 will ensure that the economic growth will remain healthy.