11.8 - Economic Growth Rates & Living Standards
Measuring economic growth rates
Economic growth rates show how much an economy expands over time. These rates are found by looking at changes in key indicators that reflect the total value of goods and services produced.
Key indicators for calculating growth rates
- Real gross domestic product (GDP) - Measures the value of all goods and services produced in a country.
- Gross national income (GNI) - Includes GDP plus income from abroad.
- Net national income (NNI) - Takes GNI and subtracts depreciation of capital assets.
Formula for economic growth rate
Where:
- New value = Indicator value in the current period
- Old value = Indicator value in the previous period
Worked example - Calculating economic growth rate
A country's real GDP was £2,000 billion last year and rose to £2,160 billion this year. Calculate the economic growth rate.
Step 1: Identify the values
- Old value = £2,000 billion
- New value = £2,160 billion
Step 2: Apply the formula
Step 3: Perform the calculation
Factors influencing accuracy of GDP data
Official GDP figures can sometimes give an incomplete or misleading picture of an economy's true size and performance. Several issues can distort these measurements, making them less reliable.
Challenges in measuring GDP accurately
- Shadow economy - Undeclared work, which is not recorded in official data.
- Tax evasion - Income that is hidden to avoid taxes, leading to underreported economic activity.
- Illegal activities - Transactions from unlawful sources, which are deliberately excluded from official statistics.
- Low literacy levels - In some areas, poor education makes it hard to collect reliable data from surveys or records.
- Non-marketed goods and services - Items produced for personal use that are not sold and thus not captured in GDP.
- Government spending effectiveness - Difficulties in assessing the true value added by public services, as their output is hard to quantify.
Factors affecting shadow economy size
The size of the shadow economy differs between countries, influenced by:
- High marginal tax rates that encourage hiding income.
- Strict penalties for illegal work.
- Strong enforcement of laws.
- Cultural views on reporting economic activities.
Comparing economic growth across countries
When evaluating growth rates between nations, direct comparisons can be tricky due to unique national circumstances. Adjustments are needed to make fair assessments.
Considerations for international growth comparisons
- Differences in shadow economies - Countries with larger undeclared sectors may appear to have slower official growth, even if actual activity is higher.
- Varying levels of non-marketed goods - Nations where more production happens outside formal markets may understate their true growth.
- Sustainability of growth - Rapid expansion that relies on exhausting resources might not last, affecting long-term comparisons.
- Depletion of non-renewable resources - Using up finite materials, such as oil, can inflate short-term growth but harm future potential.
- Environmental degradation - Pollution or habitat loss from growth can reduce quality of life, making high rates less impressive.
Assessing living standards using GDP per head
Real GDP per head divides a country's total output by its population, providing a basic measure of average wealth. However, it has several drawbacks when used to gauge living standards.
Limitations of GDP per head as a living standards indicator
- Uneven distribution - Wealth may be concentrated among a few, leaving many with low incomes despite high average figures.
- Quality versus quantity - Focuses on the amount of output rather than how well-made or useful goods are.
- Types of goods produced - Emphasis on capital goods boosts future growth but reduces current consumer goods, affecting short-term living standards.
- Working conditions and hours - Longer or harsher work may increase GDP but lower well-being.
- Environmental quality - Pollution from production can harm health and surroundings, not reflected in GDP.
- Happiness levels - Higher consumption does not always lead to greater personal satisfaction.
Shifting resources from consumer goods to capital goods lowers immediate living standards but builds capacity for better future output.
International comparisons of living standards
To compare living standards globally, GDP per head must be converted using purchasing power parity (PPP), which accounts for varying costs of identical goods in different countries.
The Big Mac index offers a simple PPP example by comparing the price of the same burger worldwide to show real buying power.
Even with high GDP per head, living standards may be low if:
- Income inequality is extreme.
- Working environments are unsafe or stressful.
- Environmental damage is widespread.
- Social issues, such as high crime or limited freedoms, persist.
Worked example - Using purchasing power parity for comparisons
Country A has a GDP per head of $60,000, and a basket of goods costs $300 there. Country B has a GDP per head of €45,000, with the same basket costing €200. Calculate the PPP-adjusted GDP per head for both in a common currency (assuming 1$ = 1€ for simplicity).
Step 1: Identify the values
- Country A: GDP per head = $60,000; Basket cost = $300
- Country B: GDP per head = €45,000; Basket cost = €200
Step 2: Calculate PPP exchange rate
PPP rate = Basket cost in A / Basket cost in B = $300 / €200 = 1.5 (A's currency is more expensive relative to purchasing power)
Step 3: Adjust Country B's GDP per head
Adjusted GDP per head for B = €45,000 × 1.5 = $67,500
Step 4: Interpretation
After adjustment, Country B's living standards appear higher than Country A's, showing PPP reveals truer comparisons.
Non-economic aspects of economic progress
Economic progress goes beyond just boosting GDP; it involves enhancing overall quality of life. True development includes factors that improve well-being without necessarily increasing output.
Key non-economic factors influencing well-being
- Leisure time - More free time for relaxation and family can raise happiness, even if it means less work and lower GDP.
- Environmental quality - Clean air, water, and green spaces contribute to health and satisfaction.
- Access to education and healthcare - Better schooling and medical services build skills and longevity, supporting long-term progress.
- Political freedom and security - Rights, stability, and low crime create a sense of safety and opportunity.