2.5.4 - The impact of economic growth

Why Growth Needs Judgement

Growth usually makes the economy larger, so there is more income and output to go around. That can benefit consumers, firms, governments, and households' living standards. However, the gains are not automatically shared evenly, and some of the biggest costs only appear over time.

This is why good evaluation goes beyond the GDP headline. An economy can grow while inflation rises, inequality widens, or environmental damage increases, so the impact of growth depends on both its size and its consequences. Population matters too: if the population grows as fast as real GDP, real GDP per capita does not rise and the average person is no better off.

Impact on Consumers

Consumers often benefit from growth through rising real incomes. If wages increase faster than prices, households can buy more goods and services and satisfy more wants. For example, if average pay rises by 5% while prices rise by 2%, real pay rises by roughly 3%. Growth can also improve living standards through lower prices or higher quality when firms become more productive, adopt better technology, and exploit economies of scale.

Growth may also create a wealth effect. During an upswing, rising house prices and share prices make homeowners and shareholders feel wealthier, which can increase confidence and spending even if those assets are not sold. In the UK, stronger housing and stock market conditions often support spending on furniture, restaurants, leisure, and domestic travel.

However, consumers do not all gain in the same way. If demand rises faster than the economy can increase output, inflation may accelerate and cut real purchasing power. Growth can also widen inequality if profits, bonuses, and asset gains rise much faster than pay at the bottom of the income distribution. Environmental damage such as pollution, congestion, and the loss of natural amenities can also reduce quality of life even while GDP rises.

Impact on Firms

For firms, growth usually means stronger sales revenue because consumer spending is rising. Higher revenue, combined with possible productivity gains, can raise profits. That makes investment easier to finance and more worthwhile, since firms expect future demand to remain stronger. In that sense, growth can create a virtuous circle of profits, investment, productivity, and further growth.

Growing markets also improve business confidence. Firms are more willing to hire workers, open new branches, develop products, and spend on research and development when they believe demand is expanding. Growth can therefore create new market opportunities for both established businesses and new entrants.

But growth also creates losers. Creative destruction means technological change and shifting consumer preferences can wipe out older business models: DVD rental businesses lost out as streaming spread, and standalone camera producers were weakened as smartphones improved. Firms selling inferior goods are especially vulnerable because these goods have negative income elasticity of demand: as incomes rise, consumers switch to better alternatives, such as from a supermarket's budget range to branded or premium products.

Even successful firms face rising costs as growth continues. As the economy approaches full capacity, shortages of skilled workers and materials push up wages and input prices, and interest rates may rise if the central bank tightens policy to control inflation, making borrowing for investment more expensive.

Impact on Government

Economic growth is usually helpful for the government's fiscal position. Higher employment and wages increase income tax receipts. Higher spending increases VAT revenue. Higher profits increase corporation tax receipts. Crucially, this can happen even if tax rates stay unchanged. Growth also helps on the spending side: as unemployment falls, the government spends less on unemployment-related benefits, so the budget improves from both directions.