GDP and What Factors Influence It Most (2024)

Gross Domestic Product (GDP) growth has direct influence on businesses. In the expanding economy with growing GDP, businesses can be a bit more aggressive and grow with the economy, while in a shrinking economy with a negative GDP growth businesses have to cut expenses drastically and re-focus on revenue stream, market and strategy. It will be useful for business managers to understand key factors that influence GDP growth.

GDP growth is mainly influenced by labor productivity and total hours worked by the labor workforce of a country. (GDP can be thought of as multiplication of labor productivity times the size of labor workforce). Labor productivity can be understood as the revenue generated by one labor-hour of the country. It means if labor productivity grows, real GDP per person grows as well (provided hours worked in a year do not decrease). Growth in total hours worked come by the growing work force. It means a shrinking labor work force will shrink the real GDP as well (provided gains in productivity are higher than the reduction in the size of the labor work force). If both labor productivity and size of labor workforce increase simultaneously, we can achieve a faster growth in real GDP.

Now, one can ask how we increase the labor productivity.The simple answer is we achieve gain in labor productivity when we save and invest in physical capital (plants, equipment and machines that generate revenue and increase revenue output per worker) increasing the amount of capital per worker; develop human capital by enhancing skill and knowledge of workforce or people who will enter the workforce. It means investing in education and training of people help increase labor productivity. Also, we do have gains in labor productivity when workforce become more comfortable in their routine business (troubleshooting problems faster and address issues proactively) and thus increase output (or GDP).

Innovation is another key factor that is a necessary ingredient in a country’s culture to continue to improve labor productivity. Innovation means building and nurturing the country’s education around innovation. This means investing in Research and Development by government and private entities. Discovery of new technologies will enhance the productivity. (It means top class school level and college level education along with great universities with big focus on R&D will be the key in a country’s competitiveness). Think about innovation (or revolution) in Information Technology in the last 20 years allowing people and businesses to be more productive (new technologies emerged in businesses based on powerful internet, network, communication tools, making business more productive). Development in Science and Technology allowed human beings to grow economic output many folds. For example, outputs of food grains and other products increased many folds due to the use of new production methods and technologies in manufacturing).

Good infrastructure also helps grow GDP faster. Goods are moved faster from one place to other place with better infrastructure, increasing our productivity. R&D findings are translated into real business products by entrepreneurs. Hence, a culture that rewards entrepreneurship helps grow GDP faster.

The other key variable that greatly impacts real GDP is the size of our workforce. In the current age, due to unfavorable changes in demographics, the size of workforce in many countries is shrinking (especially in European countries), putting great pressure on the growth of real GDP of these countries. On the other hand, the large size of workforce in countries such as China and India has become a great strength of these countries (technology has helped enhance workforce productivity along with the huge world market available to the economies due to removal of trade barriers). This workforce will become even a further advantage for these countries if the workforce in these countries is educated and made skillful). No wonder then, China and India are currently investing a large capital in education and training of their workforce. The shrinking workforce of many developed economies will continue to be concern as far as growths of their economies are concerned. The old mind-set that a smaller population is better so the fewer people can be lesser burden on limited natural resources and thus share the bigger size of the fixed size of the economic pie (Malthusian theory) is questionable now. The innovation in science and technology has increased the size of the economic pie for all. The revolution in agriculture productivity as result of improved seeds, fertilizer, pesticides, and new technologies of farming allowed enhancing agriculture outputs many folds. New technologies have allowed new products in the market to enhance productivity. For example, automobiles, computers, other IT equipment (network, phones), new medical technologies and new medicines have allowed increased economic output to grow without any limits. The new pollution control methods in developed economies have helped reduce pollution in water and air and progress has been made towards achieving sustainable environmental performance. Alternate energy resources are being explores in the form of solar, wind, nuclear and hydrogen. It seems as long as new technologies continue to emerge, new products will continue to make their way into the markets, and consumers will buy them allowing economic output to grow. Shrinking population is some countries is not able to benefit from this growth. As a result, the overall growth rate of these economies is either flat or insignificant.

The important question is if this incessant growth has any limit due to deteriorating environment (global warming) or some other natural resource limitation. Again, it seems human beings due to their inquisitiveness, boldness and enterprising nature will continue to find ways to grow and at the same time manage environmental concerns. It this holds true, labor productivity will continue to grow. If it is so, then size of the workforce will be the key factor influencing the growth of the real GDP.It means for countries which are experiencing a shrinking workforce, a possible solution is to encourage its current population to grow its workforce (provide incentive to have children) and simultaneously encourage legal immigration of skilled and educated workforce.

Immigration has been a political and social issue. Yes, Illegal immigration must be stopped or it will create law and order problem in the new country. From economic growth point of view, legal immigration may help grow the GDP. Immigration of skilled and educated workforce will be a big plus for these countries with shrinking population and through this policy they will be able to push the growth of their GDPs. Still social aspects of growing immigrant population may cause uneasiness in some in native population. Locals may think their jobs are being taken away by skilled and less expensive immigrants, causing social unrest, and emotional biases against legal immigrants. Though U.S. immigration policy in the 20th century has helped the US tremendously gain an edge over other countries in innovation (R&D) and development of new technologies, immigration issue must be handled carefully (by taking good care of those who might be displaced to other jobs due to immigration. These displaced workers must get appropriate training and placement help to find other opportunities based on their own comparative advantage). .

Thus, in summary the growth of real GDP can be sustained or enhanced by improving labor productivity and increasing the size of workforce. The labor productivity can be increased by savings and investing in physical capital and human capital. It means we must invest in training and education of people. We must invest in R&D and new technologies. We must encourage entrepreneurship. Also, we must invest in infrastructure and build and maintain good transportation modes (roads, bridges, and rail and sea transportation). Finally, we must grow our workforce size appropriately and sensibly.