Quiz 16: Creating an Environment for Growth and Prosperity

Economic growth influences the living standards of people in the sense that economic growth increases the production potential of an economy which in turn means production of more goods and services. As production increases, per person availability of goods and services also increases. When per person availability of goods and services increases, living standards of people also increases. Secondly, economic growth leads to increase in per capita income and when per capita income increases people put more emphasis on cleaner environment, good medical facilities, and better educational opportunities. All these lead to improvement in quality of life or increase in living standards. Yes, it really does make a lot of difference whether an economy grows at 2 percent or 4 percent annually. For example, as per rule of 70, a country growing at 2 percent will take 35 years (70 divided by 2) to double its income whereas a country growing at 4 percent will take 17.5 years (70 divided by 4) to double its income. So, we can see that even a difference of 2 percent in rate of growth can create a wide difference between the two countries in terms of income level when this difference is sustained over a period of time.

Trade expands the size of market available to the country. This expansion of market enables the producers to benefit from economies of scale resulting in lower cost of production and larger output. Secondly, trade enable a country or region to exploit its comparative advantage and produce goods which it can produce at lower opportunity cost and exchange with goods in production of which it does not have comparative advantage. In this way, region or economy concerned would not only be producing more but consuming more and that also the variety of goods. More production and more consumption coupled with availability of variety of goods and services imply economic growth and higher income levels. Thus, in this way, trade is an important source of economic growth and higher income level. Entrepreneurial discovery is an important source of economic growth and higher income levels in the sense that entrepreneurs are the ones who organize the production process by combining the factors of production. When entrepreneur combines the scientific knowledge with practical application and discovers the better ways of organizing the production then such discoveries, innovations or technological advancement results in higher production, lower cost per unit, and new and improved production. This results in better utilization of resources and thus increases the value of resources. More production in efficient manner with new and improved production methods means economic growth and higher and improved living standards - a synonym of higher income levels. Investment is an important source of economic growth and higher income level in the sense that investment in both physical and human capital expands the productive potential of workers. As workers became capable of producing more and that also in efficient manner, total production in the economy also increases. Apart from this, productive and efficient workers command higher wages so income levels will also increase. Thus, investment not only stimulates production resulting in economic growth but also leads to achievement of higher income levels.

It is true that poor countries have few resources for investment purpose but simply providing them more resources in terms of aid will not solve their problem of lack of growth and poverty trap. It is well known that institutional and policy environment of a country exerts very important impact on the growth and income level of the respective country. So, if a country does not have conducive institutional and policy environment in terms of strong legal system capable of protecting private property rights and enforcement of contracts in even-handed manner, minimum regulatory role of government, transparent tax structure with low marginal tax rates, and competitive markets coupled with low inflation rates then even though it gets lots of foreign aid then also most of that aid will be squandered off as wasteful expenditures or enrich the political elite of the country without contributing towards the nation building in any sense. Absence of the above stated elements only breeds corruption, inefficiency, and wastage of resources. This has been seen in case of Sub-Saharan African countries which have attracted lots of aid but have not grown due to lack of above stated institutional and policy environment. So, foreign aid only makes resources available but it does not guarantee economic growth.