Despite the benefits of economic growth, there are also potential costs, such as inflation, a current account deficit, environment costs and widening inequality.
However, the costs of economic growth will depend on the type of growth that we see.
Potential costs of economic growth include:
1. Inflation. If AD increases faster than AS then economic growth will be unsustainable. Economic growth tends to cause inflation when the growth rate is above the long run trend rate of growth. It is when demand increases too quickly that we get a positive output gap and firms push up prices.
2. Boom and bust economic cycles. If economic growth is unsustainable then high inflationary growth may be followed by a recession. This occurred in the UK in the late 1980s and early 1990s.
In the 1980s there was an economic boom with growth of over 5% a year. However this caused inflation to rise to over 10%. To reduce inflation the government increased interest rates, this caused the economy to slow down and then enter into a recession.
- However if economic growth is at a sustainable rate this will not occur. For example, between 1993 and 2007, both economic growth and inflation were at a sustainable rate.
3. Current account deficit
Increased economic growth tends to cause an increase in spending on imports therefore causing a deficit on the current account.
This shows that in the UK 1980s boom, there was an increasing deficit in the balance of goods and services. In the recession of 1991, there was an improvement in the current account. The UK is susceptible to a current account deficit during high growth because we have a high marginal propensity to import.
4. Environmental costs
Increased economic growth will lead to increased output and therefore increased pollution and congestion. This will cause health problems such as asthma and therefore will reduce the quality of life. Economic growth also means greater use of raw materials and can speed up depletion of non-renewable resources.
Higher rates of economic growth have often resulted increased inequality because growth can benefit a small section of society more than others. For example, those with assets and wealth will see a proportionally bigger rise in the market value of rents and their wealth. Those unskilled without wealth may benefit much less from growth.
However it depends upon things such as tax rates and the nature of economic growth. Economic growth can also be a force for reducing absolute and relative poverty.
It depends on the nature of economic growth. If growth is balanced and sustainable then it can occur without inflation. Also the environmental costs of economic growth can be minimised through better use of technology.
- Causes of economic growth
- Does economic growth bring increased living standards?
- Benefits of economic growth
- Latest growth figures in UK