Ever wonder what causes an economy to grow? What are the reasons that can lead an economy to crash?
To answer these questions, let’s look at the work of prominent Swedish investor, economist, and banker Peter Schiff. In his book, “How an Economy Grows and Why it Crashes”, he explored various economic concepts and topics and explained them with stories and humor.
This article presents the takeaways from that book to help you navigate the reasons for any country’s economic growth and also what can trigger an economic crisis.
Factors That Cause an Economy to Grow
Here, we will understand three concepts that can help an economy grow.
More Productivity to Meet More Demands
It is the primary role of an economy to maximize the use of limited resources to fulfil maximum human wants and needs.
If we try to break down the definition of economic growth, it is nothing but an increase in the production of goods and services in one year compared to the year prior.
An economy grows when it meets more human demands in less time, making everything more readily available to everyone than before. So, economic growth can only be achieved if the production capacity of an economy increases.
Any economy can produce more if it has more physical capital, which comes from savings and investment. Similarly, advancement in technology also fosters production and hence economic growth. With better technology, the economy can combine scarce resources more efficiently for more output.
Savings Are Integral
Various studies and research by prestigious economists have all concluded savings to be an integral component of economic growth. Any country with higher savings has witnessed more economic growth, while economic growth has been slower in countries with low savings.
If nobody in an economy saves, then there would not be any infrastructure, life-saving medicines, and even any innovation in the economy. You would not even have a smartphone if nobody saved to invest in this idea.
Similarly, it is imperative to utilize saved wealth in the most efficient manner for the prosperity of the economy.
For example, saving for consumption later, like vacations, does not aid in economic growth.
The economy grows when you loan out your money to someone for their entrepreneurial ventures or business. Similarly, if you save for investment, it is the best use of savings that will foster economic growth due to the snowball effect — what you invest enhances production which leads to economic growth,
Comparative Advantage Increases Productivity
Before beginning to understand comparative advantage, you must decipher the goal of an economy. People assume that an economic objective is to create jobs, which is not the! It is to enhance productivity.
One of the ways to increase productivity is to maximize comparative advantage. Comparative advantage is significant for all global economies and countries.
Comparative advantage is when one company or a country produces a good or service at low opportunity cost than another. So, that economy has a comparative advantage in the production of that good or service. So, it should specialize in that good or service they have a competitive advantage and trade it with others to achieve economic growth.
This way, each economy of the world will produce what it has a comparative advantage and trade it with each other to prevent unnecessary wastage of resources. Additionally, it will increase production in the country as it concentrates on what it specializes in, which it can produce in less time and cost.
All these factors eventually add up to the economic growth of the country.
What Causes an Economy to Crash?
Government is the caretaker of a country. It has to make sure that safety and justice prevail in an economy. Besides this, the government must use the taxpayer’s savings most efficiently to provide necessary services to its people.
The problem with government is that sometimes its political aspirations overshadow the need of society. So, it not necessarily always spends taxpayers’ money most efficiently. On the other hand, private lenders and investors spend money where they see more financial returns, which enhances productivity and thus leads to economic growth.
As we have already established, savings are imperative for an economy. If the government wastes taxpayers’ savings on some questionable plans, it can become a contributing factor to an economic crash.
Another contributing factor according to Peter is letting Government decide the interest rates and not the individual banks.
The government uses monetary policy to regulate the value of money and inflation by tweaking interest rates. The Central Banks determine the interest rates at which each bank can borrow or lend. If the government wants to enhance consumption and investment in the economy for economic growth, it uses expansionary monetary policy. Such policies, despite their perks, have contributed to inflation.
In the free market economy, banks should be able to set the rates themselves instead of Fed doing all the work. According to Peter, owners of individual banks have more long-term goals in mind than the Government. So, technically banks can make more informed decisions than the Government.
Similarly, since Central banks are government entities, their intentions are intertwined with the political aspirations of the Government.
Additionally, many economies have collapsed because of using borrowings or savings in the most non-sensical manner. On the other hand, banks can take better decisions on how to utilize savings in the most beneficial manner than individuals.
Economic growth is the dream of every country and economy in the world. As stated in the article, it is imperative to enhance production levels to be able to achieve economic growth. Production can be increased if more people save and use savings in the most productive ways. Similarly, if every economy produces goods and services they have a comparative advantage, it will enable them to produce more output in less time and cost.
Do you agree with Peter Schiff’s concepts explained in his book? Do let us know what more you think could be reasons for economic growth and the downfall of an economy.