Sunday, July 6, 2008

Economic Growth

This is my first article in what I am hoping would be a series of articles on economic growth.

Read this article to know why a high growth rate is essential for lifting poor countries out of powerty.

A poor country is, to state the obvious, inhabited by a lot of poor people. A very significant proportion of it's population is poor. Poor people do not earn enough money to afford the basic necessities of life, namely: nutritous food, adequate clothing, a decent house in a clean and safe neighborhood, decent quality health care and money to put their kids through at least school, if not college.
Now consider the example of a country that has 100 million poor or low income people. Let's assume that this country also has 10 million people who are middle class, upper middle class or rich. These 10 million people generate a lot of demand for food, clothing, consumer goods, automobiles, luxury goods, air travel, services such as health care, electricity, telephones, mobile phone services, high speed internet access, fast and reliable courier services and so on and so forth. Indeed this list goes on and on. Moreover, since this class of people is able to afford good education for it's children, their children go on to become well educated. When the children grow up, they land reasonably well-paying jobs. So they earn well and generate more demand for all of the above items. Thus demand for various goods and services generated from this class of 10 million people increases each year.
Unfortunately, a significant chunk of this demand is virtual, potential demand. The real demand, in terms of what people want and/or need and actually go out and buy, is much smaller. The problem is that the farms, factories and the service sectors of this country are able to satisfy only a fraction of the potential demand. The reason this is so is because, in our example country, there are price controls in effect over several items. Furthermore, the manufacturing of several items is reserved for the small scale sector, which means that they cannot be manufactured on a large scale; there are caps on the manufacturing capacity of factories, there are high import tarrifs on several goods, and several sectors of the economy are not open for private investment - domestic and/or foreign. There is also a huge disinterest within the government in providing good road, rail, airport and seaport links and on providing adequate electricity, water and telephone access. The combined effect of these policies is that the farms, factories and the service sectors of this country is either unable or unwilling (owing to a lack of sufficient incentive) to fully satisfy the demand for goods and services generated by the population of the country. Not only is the base demand not satisfied, but whatever increase in manufacturing takes place every year falls far short of the yearly increase in potential demand, leading to a ever increasing gap between what the people of this country are wishing to buy and what can be supplied. In case of essential goods this situation leads to rationing. In case of non-essential goods and services like, owning a modern car, buying a cellular phone, having Kellogs cereals for breakfast, flying rather than having to take an overnight train to the vacation destination, people have no choice but to put their disposal incomes in the bank such facilities are either completely unavailable or available in such small quantities that they are mostly not affordable for the middle class. In this situation, one would think that inflation would spiral because of a demand-supply mismatch, but it doesn't. This country experiences reasonably moderate inflation in prices. The reason for this is that, when people realize that they cannot get the goods and services that they want, they simply have no choice but to put money in the bank. An unfortunate consequence of this type of stiffling of demand is that the actual demand for goods and services grows very slowly. Consequently the year-over-year output of the factories and the service sectors of this country also grows very slowly, which in turn means that the businesses are able to hire only a small number of new employees each year. Remember the pool of 100 million poor or low income people living in this country ? Well, a large fraction of these people are eminently employable. Upon being trained, they can work in a factory, construction site or a low to moderate skill service related activity. However, with business not able to hire more than say a few thousand new people from this pool each year, powerty and unemployment fall very slowly in the best case and rise in average case because of growing population.The only way for this country to reduce powerty and increase prosperity is by creating conditions for rapidly pulling people out of the poor and low income pool by providing them with a steady source of income a.k.a. a job.This is possible if the economy of the country is able to add a significant number of new jobs each year, thereby employing a significant number of new people each year. This in turn is possible if the output of factories and service oriented industries grows by a significant amount each year - in other words - if the country experiences a high rate of growth.
Note also that as the growing economy starts absorbing available labour in the poor or low income group, these people start earning and spending and thereby adding to the demand for goods, which, in the presence of business friendly laws and regulations, will cause the factories and the service sectors to want to further increase output, which in turn will absorb more labour.
The above set of arguments also show how implementing a correct set of economic policies tailored towards creating a business friendly environment can act as a trigger for high levels of economic growth and rapid powerty alleviation.

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