The term economic growth is often used in multiple different contexts, with different definitions. Today I want to talk about what this term really means and how this one principle can help you make the right decisions in your business, short term and medium term.
What is economic growth?
When people refer to economic growth, they are referencing expansion in the economy. They’re talking about a positive output gap, however, economic growth really happens when there is an increase in full employment output over a given period.
Here are two definitions that will help you in understanding this:
Expansion = the increase in real GDP over a given period
Economic growth = an increase in full employment output over a given period
So the question really is, what determines an increase in full employment output?
The factors that determine the shift in the full employment output (also shown by long-run aggregate supply (LRAS) could be:
- Human Capital (skill level)
So when there is an increase in any of these factors, or some of these factors, the full employment output of an economy shifts because now they are producing more at full employment level – that’s when economic growth occurs. Interestingly, this can occur irrespective of where the economy is in its cycle.
It is important to understand that when referring to economic growth, we are really referring to that increase in full employment output. On the other hand, if there were to be 2 quarters of continuous economic decline or contraction, that is what is termed as a recession.
In the first example given in the video (02:32) I show that, interestingly, despite a stagnant full employment output, the economy can expand. Along with this, given a contractionary phase in the economy, the overall full employment output can still be on the rise. So there is still economic growth occurring regardless of the fact that the economy is in a contractionary phase.
This is a fascinating example and it is crucial to understand where your business sits within this.
In my next example (04:37) I plotted a graph of a typical economy, output vs price, and then compared this to how it might look right now, during a pandemic. Due to backward shifts in both Aggregate Demand (SRAD) and Aggregate Supply (SRAS), the output has declined. As a result, there is a negative output gap, which puts us in that contractionary phase, shown in the previous example.
What is happening in today’s economy?
Currently, the government is attempting to bring the cycle back into the expansionary phase and ensure that ideally the LRAS is not moving backwards but is shifted forwards. They need to make sure that there is economic growth and address the negative output gap to bring the economy back into equilibrium.
This is not about simply giving people money to spend in the economy but it is also about ensuring all the factors mentioned above do not depreciate. Thinking about the fiscal policies being brought in and considering government spend and the right kind of tax cuts.
Initially increasing government spend might shift the AD in the short-term but in the long-term, it might not address economic growth. Investment in capital infrastructure and human skill level needs to happen for this to be positively impacted. That is why certain support structures, grants have been brought in for businesses that have been in the form of new temporary tax reliefs etc. All of this has been in the interest of taking the economy back to the correct level and back into the expansionary phase.
You must understand where your business sits on the cycle now, so that you can prepare for the long-term, as well as reacting in the now, for the short-term.
In time, the spike of the pandemic will get normalised and you need to do all you can to make sure that your business is on an upward trend. That will determine the long-term asset value of your business.
What do I need to do today, for my business?
In the short-term, you will be thinking about managing the key aspects of the day-to-day running of the business.
At the same time, you need to take the time to think about what you need to do to build long-term capability for business growth:
- What kind of capital investments are you thinking of?
- How are you upgrading the technology in your business?
- How are you upskilling yourself?
- How are you upskilling your team?
These factors will determine how fast you’re going to bounce back from your contractionary phase, if you’re in that, or keep building on the expansionary phase.
Take a look at this previous post, to ensure you are not missing any blind spots in your business:
How can we help you?
Right now, we are doing exactly this with our clients. We are helping them to stay in the expansionary phase as much as possible in the current climate and, at the same time, building capacity to keep growing in the medium to long-term.
If you would like to discuss more relevant and practical strategies to help you build that long term asset value or any other aspect you may be dealing with, please feel free to get in touch. We would love to hear from you.