Economic Growth: Meaning, Measurement, Merits and Limitations

Economic Growth is increase in the capacity of an economy to produce goods and services – compared to one period to other. In simplest terms, it is the rate of change at which an economy is growing year after year or percentage change in the GDP of the country. It’s a narrow concept which focuses only on numbers, such as increased production, per capita income, spending etc. after their adjustment with inflation; population growth etc.

Which is better indicator of Economic Growth? Real national income or real per capita income?

Many a times, Economic Growth is defined as a long term increase in real national income or real national output but that may not be best indicator of growth. There are two conditions in which the value of the national output or national income may increase:

1. When the production of goods and services increases but prices of goods and service are constant.
2. When the prices of goods and services increase but production of goods and services remain constant

The Economic growth would be considered “real growth” when production of goods and services increases without increase in the prices of goods and services, because this would imply in general economic welfare of the people. However, this will be true only when population also remains stable; because then only real growth would result in increased availability of goods and services per head of population of the country. Thus, real per capita income and not the growth of real national income is a better indicator of well being of the people of a country.

How Economic Growth is measured?

The most common tool to measure economic growth is GDP, which is basically sum total of goods and services produced in the country. There are several approaches of calculating GDP. In a nutshell, these are as follows:

Expenditure Approach: In this, GDP is equal to total spending on all final goods and services (consumption goods and services (C) + Gross Investments (I) + Government Purchases (G) + (Exports (X) – Imports (M))

GDP = C + I + G + (X-M)

Income Approach: In this, GDP is calculated by adding up the factor incomes to the factors of production in the society.

GDP = National Income (NY) + Indirect Business Taxes (IBT) + Capital Consumption Allowance and Depreciation (CCA) + Net Factor Payments to the rest of the world (NFP)

• NY = Employee compensation + Corporate profits + Proprietor’s Income + Rental income + Net Interest
• CCA = Igross + Inet (I= Investment)
• NFP = Payments of factor income to the Rest Of the World minus the receipt of factor income from the rest of the world
• GDP + NFP = GNP （GROSS NATIONAL PRODUCT)

Value added Approach: Gross value added (GVA) is defined as the value of output less the value of intermediate consumption. Value added represents the contribution of labour and capital to the production process.

How Economic Growth is measured in India?

Earlier Economic growth in India was measured as change in GDP at Factor Cost and the base year used for calculating the figures was 2004-05. From January, 2015, the MOPSI made two important changes in this:

• First, the base year was changed from 2004-05 to 2011-12.
• The GDP at Factor cost was replaced by Gross Value Added (GVA) at basic prices.

This changed the definition of GDP growth in the government accounts because now GDP growth refers to GDP at market prices, which growth in economy is measured in GVA at basic prices. The relation between GDP and GVA is as follows:

• GDP = ΣGVA at basic prices + product taxes – product subsidies or
• GDP = GVA + DITS

where DITS is the difference between indirect taxes and subsidies.

The above change was done as per Pronab Sen Committee recommendations.

What are implications of using GVA instead of GDP for measuring economic growth?

Key implications of this major overhaul are as follows:

• While GDP gives a picture of whole economy, GVA gives pictures at enterprises, government and households levels. In other words, GDP is GVA of all enterprises, government and households.
• Gross Value Added (GVA) broadly reflects the supply or production side of the economy.
• The new method was also recommended by the United Nations System of National Accounts in 2008; and has made India’s figures comparable to other countries.
• The changed let to higher GDP growth instantly but now, after two years, the realistic figures have started coming in.

What are merits and limitations of measurement economic growth?

Merits

• GDP / GVA are considered to be important indicators to monitor economic growth trends and to a great extent help economic planners to understand economic welfare in quantitative terms.
• They are useful as benchmarks for policy makers and as a component to measure overall human development.
• GDP/GVA growth serves as one measure of development in both rich and poor countries.
• Further, the data on per capita income help policy makers to design policy for removal of poverty and raising standard of people.

Limitations

The limitations of measuring economic growth are as follows:

• Measuring economic growth in GDP or GVA gives only quantitative picture and does not reveal the qualitative aspects of the life of people. For example, high per capita income may not always have a well educated population or a satisfactory level of educational development.
• Economic growth is single parameters to understand and analyze the overall improvement in lives of people of a country.
• It does not count free goods or non-market goods and services, thus ignoring household activities and assigns zero values to activities such as domestic work, housekeeping work by women, care for children and elderly, cleaning, food preparation, etc. In this sense, its not gender neutral also and neglects women’s contribution to economic activities.
• It ignores distribution of income and it ignores qualitative aspects of human life.

This apart, the events such as crime, pollution, natural disasters, depletion of natural resources, accidents and diseases are counted as positive transactions because they lead to increased spending. Thus, GDP figures would ignore the welfare loss resulting from these activities.