Economic Growth of a Country: How Politics and Finance Work for it?

The International Monetary Fund (IMF) July 2022 World Economic Outlook report entitled “Gloomy and More Uncertain”, paints a picture of a contracting global economy. The geopolitical events and the negative spillovers from the higher-than-expected inflation ravaging economies worldwide have considerably weakened the fundamentals.

Economic growth or the rate at which an economy increases its economic goods, services, and human capital, is measured in terms of Gross Domestic Product (GDP). For instance, the 2021 GDP of the United States stood at $23 trillion up $2.10 trillion from its 2020 level. Over the same period, China had a GDP of $17.7 trillion while Germany, the largest economy in Europe, recorded a €3.6 trillion growth.

Politics and the economy are inseparably connected much like conjoined twins. You can hardly talk about one and leave the other out. There is an entire branch of social science known as the political economy that studies the linkage between political systems and macroeconomic phenomena.

Why Is Economic Growth Important?

Thanks to the increasing focus on economic growth, you could be there wondering why all the attention. Does economic growth matter and if yes, in what way? Well, the short and long of it is that economic growth is critical in fuelling social progress, including well-being and equity. Here are some of the benefits of a growing economy.

Enhances Living Standards

Economic growth leads to increased disposable income in the hands of the people. In turn, this increases their purchase power driving up consumption and quality of life. GDP per capita is the accepted measure of the living standard in a country.

Reduces Unemployment

An expanding economy requires more workers to ramp up production. As the economy started recovering post covid, firms in the US were scrambling to hire in an increasingly tightening labour market. In such an environment, wages almost always go up in response.

Improves Public Services

A growing economy leads to an expanded tax base and higher tax revenues for the government. This means the administration of the day has more resources to devote to the provision of public goods including education, healthcare, and environmental welfare. Economies with outstanding public service records expectedly rank high on the happiness index.

Reduces Poverty Levels

Economic growth is characterized by the availability of resources to a wide population. This means people can afford to live comfortably and fewer if any fall through the cracks of poverty. For instance, Iceland has the lowest poverty rate among the 38 member countries in the Organization for Economic Cooperation and Development (OECD). Across all age groups, its poverty rate is 4.9%, well under the 11.1% OECD average.

Does Politics and Political Instability Affect a Country’s Economy?

Economic growth and governance are integrated. A country’s political settlement framework determines how growth happens and the distribution of the benefits derived from such growth. In the United States, Congress has an oversight role over the Federal Reserve and determines the development priorities for the country.

For instance, the Government Accountability Office (GAO) argued that the coronavirus relief spending that was pushed through Congress increased federal debt. In 2019, debt-to-GDP in the US was at 79% but in 2020 the debt ratio went up to 100% of GDP. This has the potential of triggering a fiscal crisis going into the later years.

A sound political infrastructure is needed if an economy is to stay on a sustainable fiscal path. Heavy spending by the government may not always be in the best interest of immediate economic welfare and may instead lead to an increase in corporate taxes.

Political instability negatively affects the growth trajectory of an economy. Politically unstable economies cause capital flight as investors shy away and instead go to safer and more stable havens.  For instance, the political instability in Russia and Ukraine has led the IMF to downgrade Russia’s growth forecast to a 6% contraction in 2022.

How Do Finance and Politics Work Together to Have Economic Growth?

A country’s political organization must be bipartisan in policy-making if it is to enhance the economy’s fiscal outlook.  The legislature must create a long-term plan that includes rules on the debt ceiling and debt-to-GDP targets.

The government also needs to consider the country’s spending priorities and possible revenue sources to help direct resources into productive sectors of the economy. To stabilise price levels and control interest rates, the political class should give the central bank ample room to run its monetary policy without interference.

The tax policies must also favour investment. For instance, the government can establish special economic zones or give firms tax holidays to direct investments into certain sectors of the economy. Clear laws on property ownership can also spur investment and development.

Conclusion

The political environment and financial organization, both fiscal and monetary, can affect how an economy generates and distributes wealth. Focusing solely on economic growth and disregarding the politics of the day can be counterproductive. The legislature, judiciary and the executive all have a bearing on a country’s revenue and expenditure planning. It’s all about minimizing partisan tensions and having a firm grip on the economy’s fiscal path.

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