There are good and bad sides to economic growth.
"Economic growth", the way in which the economy's output of goods and services increases over time, has a major influence upon how modern societies are organised. It underpins many human activities, from buying a house to taking a job, because of the assumption that the economy will continue to grow (the annual pay rise usually requires sufficient economic growth to pay for it).
Politicians love economic growth because presiding over a growing economy is the best way for them to guarantee that they will be re-elected, short of stuffing the ballot box. The politician who presides over a recession invariably finds that they are out of a job come the next election!
The importance of economic growth was summed up by the campaign slogan adopted by Bill Clinton's team for the 1992 American Presidential Election, "it's the economy, stupid." But economic growth is not just for politicians and consumers; it has a huge effect upon your investments, perhaps more than any other factor in the long run.
Shrinking economies change spending habits
In 2008, the FTSE 100 index fell by 31%. Now it could be argued that the market fell because it had become overpriced, but the fall was largely due to investors' changing expectations for future economic growth.
Economic growth increases the demand for goods and services; this means more work for firms and thus more profits for their shareholders. But during a recession, when the economy's output declines, most consumers will cut their spending if only as a precautionary measure to build up some savings.
When times are hard many consumers will also change some of their purchasing habits, buying alternative goods which they wouldn't ordinarily have purchased, such as switching from premium brands to the supermarkets' cheaper own-label brands. When consumers' preferences can wreak havoc with companies' sales and thus their financial results because to maintain market share companies have to engage in price cutting.
For example, the multinational consumer goods giant Unilever (LSE: ULVR) recently remarked that slow economic growth had caused consumers to become extremely price-sensitive; this caused the market to mark down Unilever shares quite severely.
But an economic downturn isn't all bed news because in troubled economic times the producers of cheaper goods prosper.
More people are shopping in Poundland today than three years ago and if you're a bailiff, insolvency practitioner or loan shark you're almost certainly busier than ever! It's an ill wind that blows no-one any good!
What causes economic growth
Economists have many models of economic growth, the dominant one being the Solow model, but the consensus is that economic growth is due to three factors:
1) Technological improvements (especially new inventions)
2) Firms improving their products and processes (perhaps seeking out new markets)
3) Governments pursuing policies that promote economic growth
The levels of economic growth that we have become used to have only appeared in the last two centuries, thanks to the industrial revolution. For the vast majority of recorded human history economic growth was trivial; whilst growth of 1% a year is seen as very poor today a thousand years ago it would have represented an economic boom.
Historically cultural norms and social taboos meant that tasks tended to be performed in a particular way because that was how they had always been done. The ruling classes had no great incentive to promote change, because the one thing they wished to avoid was the disruption caused by change as this would threaten their authority.
As to technological progress, hardly anyone saw any need for it. After all, it was common knowledge that Aristotle and Ptolemy had already solved the mysteries of the universe.
Eventually things started to change thanks at first to the Hanseatic League, a twelfth century economic alliance of city states. The league's extensive trade interests meant that it took an interest in technological developments (especially in the fields of shipping and navigation) that helped their business.
But the foundations for today's levels of economic growth were laid in 15th and 16th century Italy. The Renaissance encouraged people to question the existing order and develop new ways of doing things. The floodgates were opened when Galileo (with help from Copernicus) showed that Aristotelian physics was little more than junk science, thus triggering the greatest scientific and technical boom in history.
The downside of economic growth
Economic growth isn't always beneficial -- just ask someone who loses their job because new technology has destroyed their employer's business.
Many people are highly sceptical as to whether economic growth really benefits society, particularly when it produces mass unemployment whilst the benefits of economic growth are often concentrated amongst a relatively small section of society.
Consequently policymakers sometimes try to restrict economic growth, though they won't admit so, where it would produce increased unemployment. Adopting policies of deregulation and "letting markets rip" is a good way to produce strong economic growth, as China has demonstrated for two decades, but unleashing the power of a genuinely free market can also be very destructive to existing industries and their workforce.
Consider this example. You've invented something truly revolutionary and economists reckon that when deployed it could double Britain's gross domestic product whilst putting about eight million people out of work (this isn't as crazy an idea as it sounds; radical developments in robotics and artificial intelligence could easily produce this effect).
So whilst you might become a billionaire overnight, you'd also be public enemy number one. Pretty soon lots of politicians would be speaking out against your invention, with some trying to ban it, because of the unemployment that it would produce. Growth isn't always good.
More from Tony Luckett:
> Tony owns shares in Unilever
