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4.12 The potential benefits of economic growth
KEY KNOWLEDGE
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• the measurement of economic growth using changes in real Gross Domestic Product (GDP) Source: VCE Economics Study Design (2023–2027) extracts © VCAA; reproduced by permission. Economic growth exists when a country’s economy gets bigger as a result of increasing economic activity. It occurs when there is a rise in the total volume of goods and services produced by a nation between one year and the next. This means that there are more goods and services being produced and made available for consumers, helping to increase some aspects of living standards.UNCORRECTED PAGE PROOFS
The most common measure of economic growth is the percentage change in the quarterly (i.e. every 3 months) or annual value of gross domestic product (abbreviated as GDP) or, more precisely, real or chain gross domestic product. In the case of the latter, GDP statistics attempt to estimate the total annual value of goods and services produced or sold by a nation. However, to make one year’s GDP results comparable with another’s, the exaggeration of the value of production caused by the effects of inflation (i.e. generally rising prices) or deflation (i.e. generally falling prices) is removed statistically so we can compare like with like. The resulting measure produced by the Australian Bureau of Statistics (ABS) shows changes in the real or actual volume of goods and services produced and is hence called chain volume GDP. When looking at how the size of the economy has changed, it’s really volume changes rather than price changes that we seek to measure. Thinking back to the five-sector circular flow model of the economy (see subtopic 4.4), you may recall that mention was made of the equality in the dollar values of total spending (called aggregate demand or flow 3), national production of goods and services (called GDP or flow 4), and total incomes from the sale of resources (flow 2). This means that Australia’s GDP can be calculated by the ABS using three methods shown in figure 4.21.
FIGURE 4.21 Different ways of calculating GDP to determine if there has been economic growth 1 - GDP method ($): The measurement of total output or GDP (i.e. add up the total value added to the production by businesses, of all final goods and services). 2 - Income method ($): The measurement of total incomes (i.e. add up the total value of all types of incomes received from selling different resources including wages, rent, interest, profits)
3 - Spending method ($): The measurement of total spending or AD (add up the values of the different components of expenditure on a nation’s output or AD consisting of C + I + G + X – M) Source: Shutterstock- Image 1 ; image 2,https://www.shutterstock.com/image-vector/businessman-run ning-dollar-coins-vector-business-722248384;image 3, https://www.shutterstock.com/image-photo/you ng-cute-asian-woman-holding-shopping-769147531 Hence, if Australia’s total annual value of spending in a year was $2000 billion, then both GDP and total incomes would also equal $2000 billion. All three methods of calculation provide almost identical results, although there are small differences due to inaccuracies and other limitations of data. Figure 4.22 shows changes in Australia’s GDP presented in two ways (notice that the left- and right-hand scales on the vertical axis are not measured in the same units). • Quarterly rate or percentage change in GDP (LHS): The graph columns show the quarterly percentage change in the value of GDP using the left-hand scale. This tells us the speed of change in production UNCORRECTED PAGE PROOFS against the previous period. • Quarterly level or value of GDP (RHS): The paler blue line shows the quarterly value of chain volume
GDP (measured in billions of dollars) using the right-hand scale. This tells us the total value of output in each quarter.
4 Gross domestic product, chain volume measures, seasonally adjusted
540
2 520
500
0
–2
–4
–6
–8 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 Dec-18 Dec-19 Dec-20 Dec-21 480 460 440 420 400 380
Quarterly growth Levels (RHS)
$b Source: ABS, National income, expenditure and product, see https://www.abs.gov.au/statistics/economy/national-accounts/au stralian-national-accounts-national-income-expenditure-and-product/latest-release. As can be seen, the growth in Australia’s GDP has been quite unstable between one quarter and the next, especially over the last two to three years. This volatility reflects changing aggregate demand and aggregate supply factors, and the effects of COVID-19 lockdowns and recent disruptions to domestic and international supply chains. FPO 4.11.2 Limitations of using GDP as a measure of economic growth Chain volume GDP is only an estimation of the total real value of national output or economic activity. Its measurement is complex and involves huge quantities of data from lots of sources. It is therefore not surprising that after the initial release of figures, the statistics are often revised with corrections. Even then, you should be aware of at least two main limitations: • Some production is not counted in GDP: Some non-marketed goods and services (items produced but not sold normally through the market) are excluded from the GDP figures, often because they are too hard to measure. For example: • Do-it-yourself home production such as painting, housework, parenting and gardening are not included. • Production involved in the cash economy, such as work that is paid as cash in hand and not declared to the tax office, is excluded from GDP. UNCORRECTED PAGE PROOFS • Production in the black economy (e.g. the production and sale of illegal drugs) is not included in GDP. • The value of goods and services produced by unpaid volunteers is not counted as part of GDP.
This makes GDP an underestimation of the change in the real level of national output.
• The value of some production must be imputed or ‘guesstimated’. Because of the lack of an alternative, the ABS is forced to ‘guesstimate’ or impute the value of some types of goods and services that are produced but not sold or marketed in the normal way. This may lead to inaccuracies. For example: • The value of farm production that is consumed on the farm and not sold is estimated and then included as part of GDP. • The annual value of accommodation provided by houses occupied by their owners is also estimated and added to GDP.
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Track your results and progress Find all this and MORE in jacPLUS 4.11 Quick quiz 4.11 Exercise 4.11 Exercise 1. a. Outline the three ways the annual value of Australia’s GDP can be measured. (3 marks) b. Outline two weaknesses that limit the accuracy of using this measure of economic growth. (2 marks) 2. Examine table 4.15 showing the hypothetical data for an economy. Using only the relevant items from the table, calculate the value of GDP ($ billions) using the total spending method. Show how you calculated the answer. (2 marks) TABLE 4.15 Hypothetical data for an economy used to estimate GDP Item from the circular flow model Value ($ billions) Household consumption $1600 Saving $100 Business investment $200 Government taxes $50 Government spending $40 Export spending $10 Import spending $5 Fully worked solutions and sample responses are available in your digital formats. UNCORRECTED PAGE PROOFS
KEY KNOWLEDGE
• the potential benefits of economic growth, such as growth in material living standards, improved non-material living standards, employment opportunities and economic development
Source: VCE Economics Study Design (2023–2027) extracts © VCAA; reproduced by permission.
It is difficult to deny that economic growth (higher levels of national production) has helped most Australians to enjoy better material living standards and has probably even improved some aspects of our non-material wellbeing. These benefits are summarised in figure 4.23.
FIGURE 4.23 Summary of the main benefits of strong economic growth The potential benefits of strong rates of economic growth
Creates new employment opportunities and lowers unemployment Increases personal incomes, purchasing power and material living standards
Improves government finances by lifting tax revenues and reducing welfare outlays
Improves some aspects of non-material living standards Given these potential benefits, its no wonder that the Australian government promotes the goal of a strong and sustainable rate of economic growth or the fastest rise in GDP that is possible (perhaps an average increase of around 3 per cent a year) without causing a serious inflation or jeaopardising the achievement of other important government economic and environmental goals. 4.12.1 Strong economic growth creates new employment opportunities and lowers unemployment Strong economic growth and rises in real GDP create extra jobs, helping to keep unemployment rates at lower levels. Indeed, one of the Australian government’s important aims is to achieve the goal of full employment. This is defined as the lowest rate of unemployment, perhaps at around 4.0 to 4.5 per cent of the labour force, that does not cause inflation to accelerate. As illustrated in figure 4.24, one benefit of strong economic or GDP growth of at least 2 to 3 per cent a year is that it usually helps to lower Australia’s unemployment rate (e.g. during 2017–19 and 2020–22). This is because when there is economic growth, firms usually need to hire or employ more staff to lift their production levels. By contrast, weaker rates of economic growth, below 2 per cent, mean that cyclical unemployment soon rises. For example, during the COVID-19-induced recession in 2020–21, annual GDP growth was 0 per cent. This caused monthly unemployment to peak at 7.4 per cent (the actual figure was over 11 per cent but was artificially kept down by the government’s JobKeeper wage subsidy scheme to keep people employed). 4.12.2 Strong economic growth increases personal incomes UNCORRECTED PAGE PROOFS and material living standards
In general, income is earned by those who sell resources to the business sector and take part in the production of goods and services. The more people produce and sell growing GDP, the more income is earnt. One measure of material living standards is real GDP per capita. Its level is very closely related to average incomes per head and can be calculated as follows:
The relationship between Australia’s annual rate of economic growth (percentage change in real GDP) and the unemployment rate (percentage of the labour force)
8 Rate of GDP growth and unemployment 2 3 0 2015–16 2016–17 2017–18 2018–19 2019–20 2020–21 2021–22 2022–23 2023–24
2.7 2.3 2.9 2.1 0
4.9 1.5
7.1 Rate of economic 7 growth (year ended June, percentage change in Chain volume GDP, reference year 2019–20) Unemployment rate (percentage of labour force at June) 5.25.4 5.75.9 4 5 6 Source: Data derived from ABS, Labour force, https://www.abs.gov.au/statistics/labour/employment-and-unemployment/ labour-force-australia/latest-release; National income, see https://www.abs.gov.au/statistics/economy/national-accounts/ australian-system-national-accounts/latest-release. Average real GDP (income) per head ($) = real value of GDP ($) -:- population size For example: If GDP equaled $1000 and the population size was 100, then average GDP (income) per capita would equal $10 (i.e. $1000 -:- by 100), as would total incomes. When economic growth is strong, and GDP is rising at a faster rate than the rate of increase in our population size, average per capita incomes and consumption levels increase. This is because to lift production, firms employ more resources including labour. As a result, wages and total incomes rise. However, when GDP growth is negative or increases very slowly, average per capita incomes fall. This is the result of firms cutting production due to a lack of spending. They employ fewer resources, unemployment rates climb, and more people end up on meagre welfare benefits of perhaps $300–400 per week, rather than perhaps receive average weekly wages of around $1740 per week. Clearly, their consumption levels and living standards will fall dramatically. Figure 4.25 shows the change in average real GDP (income) per capita. Notice that: • overall, average real GDP per capita has increased substantially over the period leading to higher incomes, consumption and material living standards • the rise in average GDP per capita was faster in some years (e.g. 2011–12) than in others • that there were only two years where average real GDP failed to record an increase on the previous year’s level — 2008–09 (the global financial crisis) and 2019–20 (the COVID-19 recession), lowering consumption and living standards. Overseas experience has also impressively demonstrated why strong economic growth is so important. As shown in figure 4.26, the spectacular rise in the average rate of global economic growth, from 4.3 per cent in 1960–2000 to 1 UNCORRECTED PAGE PROOFS 6 per cent in 2000–10, saw a dramatic reduction in extreme poverty (people surviving on less than US$1.90 per day) by over one billion people in the 25 years between 1990 and 2015. An article in the Economist claimed that two-thirds of this reduction can be credited to strong global economic
