What do economists believe causes economic growth?

Economic growth is measured by how much gross domestic product, or GDP, increases from one period to the next. GDP is the combined value of all goods and services produced within a country. While economic growth is easy enough to define, identifying with certainty what causes it has vexed economists for decades.

No consensus exists regarding the best measures to stimulate the economy. In fact, the two most popular schools of thought on how to do so directly contradict one another. Supply-side economists believe that making it easier for businesses to supply goods is the key to creating a fertile environment for economic growth, while demand-side economists counter that stimulating the economy requires increasing the demand for goods by putting money into consumers' hands.

Supply-Side Economics

Supply-side economics is a term first coined in the mid-1970s and became popular during the Reagan administration in the 1980s. Economists who favor supply-side policies believe that when businesses have an easier time supplying goods and services to consumers, everyone benefits as increased supply leads to lower prices and higher productivity. Furthermore, a company increasing productivity necessitates an investment in additional capital and the hiring of more workers, both of which stimulate economic growth.

Economic policies favored by supply-side economists include deregulation and lower taxes on businesses and high-income individuals. If the market is allowed to operate largely unfettered, it will naturally operate more efficiently. Supply-side economics is closely related to trickle-down economics, a theory stating that policies benefiting the wealthy create prosperity that trickles down to everyone else. For example, when the rich receive a tax break, they have even more money to spend in their communities or start businesses that give people jobs.

Demand-Side Economics

At the other end of the spectrum is demand-side economics, popularized in the 1930s by economist John Maynard Keynes. Economists who ascribe to this viewpoint believe the economy grows when demand, not supply, for goods and services increases.

According to demand-side economic theory, an increase in supply without corresponding demand ultimately results in wasted effort and wasted money. By first increasing demand, increases in supply naturally follow as businesses grow, expand, hire more workers and increase productivity to meet the new levels of demand.

To increase demand, recommended policy measures include strengthening social safety nets that put money into the pockets of the poor and redistributing income from the wealthiest members of society. According to Keynesian theory, a dollar in the hands of a poor person is more beneficial to the economy than a dollar in the hands of a rich person because poor people, by necessity, spend a high percentage of their money, while the wealthy are more likely to save their money and create more wealth for themselves.

The Bottom Line

The debate over whether supply-side or demand-side economics is superior is far from settled. While supply-side economists love to take credit for the economic prosperity of the 1980s and 1990s that followed Reagan's deregulation and tax cuts on the wealthy, demand-side economists counter that these measures led to a bubble economy, as evidenced by the dot-com bubble that rapidly expanded and subsequently burst in the late 1990s, and the similar situation with real estate and the financial crisis during the late 2000s.

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