A slower rate of economic growth means living standards will increase at a slower rate (or not at all) unemployment could increase. It is also likely to mean lower inflation and lower interest rates.
For example, in the post-war period, western economies grew at 2.5% to 4.% per year. However, since the early 2000s, growth rates have slowed down. This process of slower economic growth is sometimes known as ‘secular stagnation.‘
It’s not just the UK, average economic growth rate in the Eurozone, Japan and US is lower than in 1960s
The effects of slower economic growth could include:
1. Lower income growth
Since the financial crisis, there has been very limited increase in UK real GDP per capita. Median wages have virtually stagnated. With slower increase in living standards – inequality may become more noticeable to those on lower incomes.
Higher debt
Since the slowdown in economic growth, the government has received less tax revenue than expected, at the same time, spending on health care, welfare and pensions has increased. Therefore, there has been a rise in the debt to GDP ratio. This is particularly a problem because the slowdown in growth is partly related to an ageing population leading to higher demand for medical care and old-age pensions is growing faster than the low rate of economic growth.
A rise in unemployment
If productivity is growing at 3% a year, then new technology will enable firms to produce more output with fewer workers. When new technology is increasing labour productivity it becomes more important for economic growth to create new jobs lost by productivity gains. For example, China was growing at over 7% a year – due to rapid growth in productivity and improvements in efficiency. But, as China’s growth rate slows down we are seeing a rise in Chinese unemployment (especially youth unemployment). Because the economy is not expanding fast enough to create jobs lost by new technology.
An alternative to rising unemployment is a rise in ‘disguised unemployment‘ This is when workers gain fewer hours than they would like. Rather than full-time work, they only get part-time work. Since 2010, UK unemployment has generally been low, but the low rate of economic growth has contributed to more part-time and insecure work.
Lower inflation (possibly)
With lower economic growth, you would expect to see lower inflationary pressures. However, if slower growth is caused by a slow down in productivity growth, then the economy may reach full capacity sooner, and therefore, you may still see inflationary pressures. Despite lower economic growth, the UK had an inflation surge in 2022, though this was due to cost-push factors.
Lower interest rates
As growth slows down, the base rate set by the Central Bank is likely to fall. This is to try and stimulate economic activity. Also, if lower growth leads to lower inflation, there will be more room for rate cuts without conflicting with inflation target.
This shows how lower economic growth in the UK has led to a lower trend of interest rates. (not withstanding the increase in 2023/24) Lower interest rates have consequences for the return from savings. Savers will get less. But, it will be cheaper to borrow and get a mortgage. Interestingly slower economic growth and the decline in mortgage rates has played a role in boost the ratio of house prices to income. With cheaper mortgages the incentive to buy rises.
You might expect slower growth to reduce house prices, but this has not really happened. Although income is an important determinant of housing demand, interest rate effect is greater.
Less investment
Despite lower interest rates, the effect of slower rates of economic growth will be to reduce levels of investment. Firms invest on the prospect of a rise in demand. If growth is slowing, there is less reason to invest. The lower investment can then itself contribute to lower economic growth. This is behind some of the theories of secular stagnation. The idea advanced western economies are slowing down due to ageing populations and decline in investment.
Better environment
- With slower economic growth, there will be less growth in production and this could make it easier to reduce Co2 emssions. Less strain on environmental resources than expected. Slower growth in the UK (especially decline in industrial sector) is one reason for falling CO2 per capita. Though bigger reason was ditching coal.
Evaluation of slower growth
1. Temporary/permanent. If slower growth is just temporary, then the economy can bounce back. For example, in a recession, demand falls, but if interest rates are cut, the economy can bounce back. However, if the slowdown in growth is due to long-term structural factors, then the effect will be different
2. Impact of Slower Growth depends what causes it
The effect of slower economic growth also depends on what causes slower growth. Slower growth could be two main factors
- Lower productivity growth (supply-side factors) – this will mean inflation could still be a problem
- Weak aggregate demand (demand-side factors) – this might be just temporary fall in growth and the economy could bounce back.
Diagrams showing slower economic growth
Slower economic growth due to low productivity growth.
Suppose the economy used to have productivity growth of 3%. Then real GDP increases from Y1 to Y3, and therefore, we get strong economic growth.
However, if productivity only increases by 1.5% a year, then the economy expands only from Y1 to Y2.
Slower economic growth due to weak aggregate demand
The other main cause of low economic growth is weak aggregate demand. If demand-side factors are weak, then the economy is more likely to experience a negative output gap – real GDP is less than potential GDP.
In this case, there is a small increase in AD but productive capacity increases at a faster rate. This leads to a negative output gap (Y2 is less than Yf)
If slower growth is due to weak aggregate demand (e.g. due to low confidence, high-interest rates, falling house prices) then the low growth rate will give similar effects to a recession. – lower income, higher unemployment and lower inflation.
Benefits of lower rates of economic growth
- Environment. With lower rates of economic growth and lower rate of increasing national output, it will be easier to meet targets for reducing carbon emissions. If growth is very rapid, there is more pressure to produce quick and cheap energy, which may require burning fossil fuels. Lower rates of economic growth give more chance to shift to renewable energy. Lower rates of growth will also slow down the rate of consuming non-renewable resources which may be beneficial for the very long-run.
- Lower inflation. With lower growth rates, there is less inflationary pressures. This means the Central Bank can keep interest rates lower, which is good for borrowers, mortgage holders and the government selling bonds. Low inflation creates the stability which may encourage more investment.
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