What Is Economic Growth?Summary: Politics, government spending, inflation and much more are all impacted by the performace of a national economy. Here we attempt to explain some of these relationships, and their impact on the stock market. To do this, we simply ask, "What is economic growth?" Television news broadcasts often tell us about the performance of the economy. It is a vital piece of information in the way in which our part of the world operates. However, in the modern world, it is a collection of numbers rather than just one. Things like property prices, rates of inflation and consumer spending all have an important place in this puzzle. The central piece of this puzzle though is gross domestic product (GDP) which is a measure of the output of an economy. For ease, it is easy to think of output as being the finished goods or services. Therefore, rather than the parts of a car, it is easier to think of the car itself. Needless to say, in the globalised world in which we live, such numbers are coming under increasing pressure as to their meaning and relevance. The days in which all the parts of a car were made within a short distance of the factory that assembled the car are long gone. The job of GDP is to try and combine all this economic 'activity' into one number that can be followed. Then, over time, trends can be seen as to whether this number rises or falls, and thus, whether an economy is increasing or decreasing in size. This increase in GDP, reflects economic growth.
For example, an economy may be able to generate more finished products without the need of additional resources. This may mean that processes have been made more efficient or perhaps that people are working harder. These are known as productivity gains. However increases may be obtained, this extra output will normally lead to other things. These other things may include pay rises for the workforce (an increase in expenditure), additional money being spent on research and development for new products and a greater amount of money (hopefully in the form of profits) on the balance sheets of companies. It is this increase in corporate profits that can then lead into higher valuations of companies with a stock market listing and on to a rising stock market. As more and more companies are in possession of more and more retained profits, the cumulative impact ought to lead to vastly increased stock market valuations.
This slowdown is more normally called 'negative economic growth', suggesting that the GDP number is no longer rising. Numbers below 0 are considered negative. There is also the sometimes tricky issue of a 'slowdown in economic growth' to deal with. In some more dynamic (usually emerging or developing economies) growth might be in the high single digits - for example 7% pa. Should that number fall, but still be positive - for example dropping to 5% pa - there is still growth but at a slower rate. Stock markets and currency markets usually react poorly to such news, despite the fact that the economy is still growing. This is because the market has - wrongly it seems - priced in continuing growth at the higher number. Now that GDP is growing less quickly than previously, assets may be overpriced, causing a correction of some kind. The growth, bull markets and bubbles of the years between 1990 or so and 2007/8 lead to a rise in borrowing to fund speculation. In an ideal world, we will all use economic growth to repay debts and strengthen our financial positions, so that we will be able to borrow if required during a slowdown. This approach (that is being very poorly paraphrased!!) dates back to the thoughts of John Maynard Keynes - called Keynesian economics - though he applied to governments rather than individuals. In contrast, many organisations and individuals borrowed heavily, 'investing' (though many were really gambling) that the good times will last. Sooner or later, the crisis of confidence comes and everything collapses around us. To read more pages on related topics, please follow these links:
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