Intro: While there are many factors which help determine real GDP growth rates across countries, countries with low levels of GDP per capita, high levels of human capita, political stability, financial stability, econoomic freedom, and business freedom will tend to experience rapid growth. High savings rates are also a key factor, along with growth in a country’s active labour force.
Economic growth is driven by businesses deploying scarce land, labour, and human and physical capital to create more productive ways of providing goods and services. Factors such as political stability, financial stability, the quality of a country’s business environment, the level of economic freedom, and the quality of a country’s labour force determine the productivity of investment. Meanwhile, the higher a country’s savings rate, the more resources that are available for investment. In addition to the availability of savings and the productivity of investments made with such savings, labour force growth plays an important role.
Political Stability
There is no ideal political framework that is more conducive to growth than another as much depends on the stage of economic development and country-specific factors. Nonetheless, the more stable a political system, all else equal, the more likely it is that economic growth will be fostered. Of course, should a country’s political system shift away from being extremely authoritarian, we should expect this to benefit long-term growth, but the reason for this is likely to be captured in other areas such as a more open business environment and greater economic freedom.
Financial Stability
Financial stability reflects the likelihood that a build up of financial liabilities could act as a drag on growth. The most damaging in terms of economic growth is an excess of external debt. A large level of external debt requires constant payments to overseas investors which serves to deplete scarce resources that could otherwise be used for investment. Additionally, high external indebtedness raises the potential for economic shocks should foreign investors lose confidence in the country’s ability to repay. On the domestic side, high levels of public or private debt can also create shocks to the economy in the event of rising real interest rates. Meanwhile, other financial imbalances such as the prevalence of low or negative real interest rates can act as a drag on the productivity of investment and the availability of savings.
Business Environment
The more efficient a country’s business environment, the greater the ability of entrepreneurs to uncover profit opportunities and generate productivity gains. Factors such as well-developed infrastructure, a lack of corruption, and a lack of impediments to opening and running a business show a close positive correlation with GDP per capita as they allow more productive investment to take place.
Economic Freedom
The greater the level of economic freedom of individuals within a country, the greater the prospect of more productive investment taking place. Factors such as the ability of investors to easily hire and fire workers, a low level of government spending, security of property rights, and the ability to trade across boarders allow businesses greater ability to generate profit opportunities and generate economic growth.
Human Capital
The more educated and intelligent a country’s labour force, the greater potential for high levels of GDP per capita. Countries with high levels of human capital and low levels of GDP per capita tend to be those that have suffered from unfavourable political environments which have curtailed the ability of the population to build wealth. In contrast, countries with high levels of GDP per capita but low levels of human capital tend to be those which have benefitted from fortunate resource endowments.
GDP Per Capita
The lower a country’s GDP per capita, the higher the potential for rapid real GDP growth as the economy benefits from the adoption of technology. This does not mean that poor countries will automatically grow faster than wealthier countries, but it does mean that all else equal poorer countries will have a higher marginal return on investment, helping support real GDP growth.
Savings
The link between savings and growth is quite complex. Savings are the cornerstone of growth as all investment that takes place must comes from production which has not yet been consumed; i.e. savings. The higher the rate of saving in any economy, the greater will be the level of investment, and, all else equal, the higher the rate of growth. China’s rapid growth rate over recent decades is partly due to the country’s high savings rate, which has at times exceeded 50% of GDP.
That said, countries with high savings rates today will face future drags from depreciation and so it is not necessarily the case that a country with high savings rates in the present will experience rapid growth in the future. What tends to be a more important driver is the change in a country’s savings rate, and a key driver of this is demographics. The greater the share of working age population in any country, the higher the level of potential savers relative to dissavers. A country with an ageing population will tend to face a natural drag from a lower savings rate, all else equal.
Labour Force Growth
The faster the growth of the working age population, the faster the growth of real GDP will be. Increased labour supply does not just create output automatically, it does so through increasing profits; the increased pool of labour leads to increased productivity of investment, boosting real GDP growth.
