GLOSSARY OF TERMS (2)

Growth:

Growth is what economic activity is all about, but how can it be made to happen? Economists
have plenty of theories, but none of them has all the answers. Adam Smith attributed growth to
the invisible hand, a view shared by most followers of classical economics. Neo-classical
economics had a different theory of growth, devised by Robert Solow during the 1950s. This
argued that a sustained increase in investment increases an economy's growth rate only
temporarily; the ratio of capital to labor goes up, the marginal product of capital declines and
the economy moves back to a long-term growth path. Output will then increase at the same
rate as the growth in the workforce (quality-adjusted, in later versions) plus a factor to reflect
improvements in productivity.

This theory predicts specific relationships among some basic economic statistics. Yet some of
these predictions fail to fit the facts. For example, income disparities between countries are
greater than the differences in their savings rates would suggest. Moreover, although the model
says that economic growth ultimately depends on the rate of technological change, it fails to
explain exactly what determines this rate. Technological change is treated as exogenous.

Some economists argued that doing this ignored the main engine of growth. They developed a
new growth theory, in which improvements in productivity were endogenous, meaning that
they were the result of things taking place within the economic model being used and not
merely assumed to happen, as in the neo-classical models. Endogenous growth was due, in
particular, to technological innovation and investments inhuman capital. In looking for
explanations for differences in rates of growth, including between rich and developing
countries, the new growth theory concentrates on what the incentives are in an economy to
create additional human capital and to invent new products.
Factors determining these incentives include government policies. Countries with broadly free-
market policies, in particular free trade and the maintenance of secure property rights, typically
have higher growth rates. Open economies have grown much faster on average than closed
economies. Higher public spending relative to GDP is generally associated with slower growth.
Also bad for growth are high inflation and political instability.

As countries grew richer during the 20th century annual growth rates declined, as a result
of diminishing returns to capital. By 1990, most developed countries reckoned to have long-
term trend growth rates of 2-2.5% a year. However, during the 1990s, growth rates started to
rise, especially in the United States. Some economists said this was the result of the birth of
a new economy based on a revolution in productivity, largely because of rapid technological
innovation but also (perhaps directly stemming from the spread of new technology) to increases
in the value of human capital.

GDP (Gross Domestic Product):

It is a measure of economic activity in a country. It is calculated by adding the total value of a

country's annual output of goods and services.

GDP = private consumption + investment + public spending+ the change in inventories +

(exports - imports).

It is usually valued at market prices; by subtracting indirect tax and adding any
governmentsubsidy, however, GDP can be calculated at factor cost. This measure more
accurately reveals the income paid to factors of production. [Adding income earned by domestic
residents from their investments abroad, and subtracting income paid from the country to
investors abroad, gives the country's gross national product (GNP)].
GDP can be calculated in three ways. The income method adds the income of residents
(individuals and firms) derived from the production of goods andservices. The output method
adds the value of output from the different sectors of the economy. The expenditure method
totals spending on goods and services produced by residents, before allowing
fordepreciation and capital consumption. As one person's output is another person's income,
which in turn becomes expenditure, these three measures ought to be identical. They rarely are
because of statistical imperfections. Furthermore, the output and income measures exclude
unreported economic activity that takes place in the black economy but that may be captured
by the expenditure measure.

GDP is disliked as an objective of economic policy by some because it is not a perfect measure
of welfare. It does not include aspects of the good life such as some leisure activities. Nor does
it include economically valuable activities that are not paid for, such as parents teaching their
children to read. But it does include some things that lower the quality of life, such as activities
that damage the environment.

GNP (Gross Net Product):

Short for gross national product, another measure of a country's economic performance. It is
calculated by adding to GDP the incomeearned by residents from investments abroad, less the
corresponding income sent home by foreigners who are living in the country.

Capitalism:

Capitalism is a free-market system built on private ownership, in particular, the idea that owners
of capital have property rights that entitle them to earn a profit as a reward for putting their
capital at RISK in some form of economic activity. Opinion (and practice) differs considerably
among capitalist countries about what role the state should play in the economy. But everyone
agrees that, at the very least, for capitalism to work the state must be strong enough to
guarantee property rights. According to Karl Marx, capitalism contains the seeds of its own
destruction.
Progress:

The idea that the world can become increasingly better in terms of science, technology,
modernization, liberty, democracy, quality of life, etc.

 Social progress, the idea that societies can or do improve in terms of their social,
political, and economic structures.
 Scientific progress, the idea that science increases its problem solving ability through the
application of some scientific method.

 Philosophical progress, the idea that philosophy has solved or at least can solve some of
the questions it studies.

 Idea of Progress, the theory that scientific progress drives social progress; that advances
in technology, science, and social organization inevitably produce an improvement in the
human condition.

HDI (Human Development Index):

It is a composite statistic of life expectancy, education, and income per capita indicators, which
are used to rank countries into four tiers of human development. A country scores higher HDI
when the lifespan is higher, the education level is higher, the GDP per capita is higher, the
fertility rate is lower, and the inflation rate is lower. The HDI was developed by the Pakistani
economist Mahbub ul Haq working alongside Indian economist Amartya Sen, often framed in
terms of whether people are able to "be" and "do" desirable things in their life, and was
published by the United Nations Development Programme.