Drivers of an economy

Economists, analysts and the majority working in the financial services sector, speak regularly and monitor closely GDP, unemployment figures, inflation. Why is it all important? Amongst many others, these are the main drivers of a country’s economic performance.

A country’s workforce is a proportion of the country’s population. Generally 18-65 year olds that are eligible to work are considered to make up the work force. An employed work force combined with a presence of capital resources and technological improvements through investment makes up the GDP of a country. These factors can then be reviewed on a per capita basis to measure efficiency and productivity of output.

Economic Output is the result of the above factors. Generally a proportional increase in all inputs leads to higher economic growth, yet developed countries, many a time have the capital factor of economic output operating near full capacity. This would leave economic growth to depend on additional labour and/or technological progress.

It is hence why GDP per capita is often an additional tool to measure the progress and efficiency of economic growth. Additional labour given an amount of capital resources, benefits the economy up to a point where the utility of additional labour given available capital reduces production efficiency, and the rate of GDP growth per capita.

Developed economies therefore emphasise a great deal on Human Capital over and above physical capital to ensure that continued innovation through education helps sustain and boost economic growth through technological progress to support the Labour and Capital factors.

Fiscal and monetary policies can then be used by governments to intervene in the economy to control investment, capital flows, currency fluctuations, unemployment and inflation.

Inflation is historically inversely related to unemployment. The lower a country’s interest rates are, the more investment arises from borrowing, leading to increased demand, and inflation through higher product prices. Governments usually then intervene when inflation reaches unsustainable levels and the economy is operating beyond its long term output given available labour and capital resources. Examples come in the form of restrictive monetary and fiscal policies.

Higher interest rates would curb inflation, reduce investment and increase saving by consumers. Capital inflows would in fact occur as higher interest rates attract foreign demand for the country’s currency given the higher savings rate.

Monetary policy is then often used to curb excess appreciation of a nation’s currency, which would ultimately make it uncompetitive vs foreign peers, especially for a country’s reliance on exports.

Developing economies, notably emerging markets, generally benefit off higher GDP growth rates. Their capital resources would be much lower than their developed economy peers and hence have much upside to gain, when increasing capital investment, adopting technological innovations and promoting participation of the work force.

Over time, through globalisation, free trade, and limited capital restrictions GDP growth of these developing nations are expected to converge to the long term average of developed nations. China for example has for the past decade had a superior and positive GDP growth rate, which albeit is still increasing, is doing so at a much slower pace, hinting that the nation is continuing to converge from a developing to a developed economy.