What is economic growth?

What does it take for a country to provide better healthcare, education, and infrastructure for its people? All of it depends, in one way or another, on economic growth. But what actually drives it? The most influential answers come from a handful of Nobel laureates, including Robert Solow, Paul M. Romer, Daron Acemoglu, and Simon Kuznets.

This article explores what economic growth is, how it works, how it is measured, and what the research tells us about how to sustain it.

Economic growth is the sustained increase in the production of goods and services in an economy over time, most commonly measured by the growth rate of real gross domestic product (GDP).^{1, 2} It is a central concern of macroeconomics, as it influences how fast incomes rise, how quickly poverty falls, and how much governments can invest in public services.

Economic growth can be short-lived or structural. Short-run growth follows the ups and downs of the business cycle, while long-run growth reflects how much an economy can actually produce over time.³ Even small differences in annual growth rates, sustained over decades, can separate a prosperous country from a poor one.

Several Nobel laureates have done the most to explain what drives that long-run growth. Robert Solow, who won the prize in 1987, showed that technological progress is the primary driver, not just the accumulation of capital.⁴

Paul M. Romer, awarded the prize in 2018, took that further by showing that technology itself is the product of deliberate investment in research and development.⁵Daron Acemoglu, recognized in 2024 alongside Simon Johnson and James Robinson, demonstrated that institutions matter just as much, as societies with a poor rule of law and exploitative governance do not generate sustained growth.⁶

Economic growth at the national level draws on many interconnected forces. These include capital, labor, technology, and the institutions that shape how they come together.

Capital and labor

More machines, better infrastructure, and a larger workforce all raise an economy’s output. But Robert Solow’s 1956 model revealed an important limit. The more capital an economy accumulates, the smaller the boost each additional unit provides. A country can keep building factories, but eventually each new one adds a little less growth than the last.⁷

This means capital accumulation alone cannot sustain growth indefinitely. What keeps an economy moving forward, Solow concluded, is technological progress, because better technology makes workers and machines more productive regardless of how much capital already exists.⁴

Technology and ideas

Technology, in Solow's model, is the missing engine. Paul Romer's work explains why. Romer showed that ideas, unlike machines or workers, are non-rival.⁸ One company using an idea does not stop another from using it too. In other words, a new production method, once discovered, can spread across an entire economy at almost no additional cost.

Take a medical breakthrough as an example. Once a new treatment is discovered, any hospital in the world can apply it without diminishing its value to anyone else. The same logic applies to software, engineering methods, and agricultural techniques.

This is why growth driven by the accumulation of ideas does not face the same diminishing returns as physical capital, and can therefore be sustained over time.⁵ Investment in research and development is not just a good policy. It is the mechanism that keeps economies growing.

Institutions

Technology and capital can only do so much if the rules governing an economy are weak or poorly enforced. Daron Acemoglu, Simon Johnson, and James Robinson, who were awarded the Nobel Prize in 2024, demonstrated that the quality of a country’s institutions is a fundamental determinant of its prosperity.⁶

Their research shows that societies with a poor rule of law and institutions that extract wealth for a narrow elite, rather than distributing opportunity broadly, do not generate sustained growth.⁹

These forces do not operate in isolation, and the laureates' research makes clear why all three matter together. A country can have advanced technology but weak governance, or strong institutions but an insufficient capital base. But growth is shaped by many conditions beyond these three alone.

Understanding how economies develop over time is as important as understanding what drives growth. In 1960, economist W.W. Rostow proposed a five-stage model in his book The Stages of Economic Growth: A Non-Communist Manifesto that offered one of the first systematic accounts of how societies move from traditional agricultural economies to modern industrial ones.¹⁰

1. Traditional society

In the earliest stage, most economic activity is agricultural. Technology is what Rostow called pre-Newtonian, meaning societies have not yet learned to apply modern science systematically to production. Output per person hits a ceiling because the tools for breaking through it do not exist.

2. Preconditions for take-off

In the preconditions stage, societies begin laying the groundwork for sustained growth. Commerce, education, and transport start to develop together, savings rates rise, and banks and other institutions for mobilizing capital appear.

Rostow saw the formation of a centralized national state as almost universally necessary before take-off could follow, alongside a broader shift in outlook as people began to believe that economic progress is not just possible but worth pursuing.

More recent work by Daron Acemoglu and colleagues shows just how much these institutional foundations matter. Societies that developed inclusive institutions tended toward long-run prosperity, while those built on extractive ones often stayed poor for generations.⁶

3. Take-off

The take-off is the stage where growth becomes self-sustaining rather than sporadic. The forces driving modernization come to dominate the society, and growth becomes its normal condition.

From there, the pace of change becomes visible. Manufacturing takes the lead, and the rate of investment and savings rises sharply, in Rostow's estimate from around 5 percent of national income to 10 percent or more.

New industries expand quickly, profits get reinvested, and cities grow as workers move from farms to factories. By the end of this stage, both the economic and social structure of the country look fundamentally different from what came before.

4. Drive to maturity

In the drive to maturity, the economy stops depending on the handful of leading sectors that powered the take-off and begins to grow across a much wider front.

As an illustration, a country within this economy may shift from the heavy-industrial industries such as coal and iron into more complex sectors like machine tools, chemicals, and electrical equipment, and the country finds its place in the international economy with new export commodities. Rostow estimated that this stage takes around 60 years from the beginning of take-off.

5. Age of high mass consumption

In the final stage, the economy has enough productive capacity that basic needs are broadly met. Leading sectors shift toward durable consumer goods and services, with the mass-produced automobile as Rostow's signature example.

Living standards are high enough that the country can direct resources toward social welfare and leisure rather than expanding productive capacity. The questions that dominated earlier stages give way to new ones about how growth's benefits get distributed.

Economic growth is most commonly measured as the percentage change in real gross domestic product between two periods.²Economists refine the basic formula of economic growth rate in several ways depending on the question they are asking.

Basic GDP growth rate

The standard formula for calculating economic growth is ((GDP₂ − GDP₁) / GDP₁) × 100, where GDP₁ is the r eal G DP from the previous year and GDP₂ is the real GDP from the most recent year. The result, expressed as a percentage, shows how much the economy has expanded or contracted between the two periods.¹¹

Real versus nominal GDP

Nominal GDP is measured in current prices, while real GDP adjusts for inflation. Only real GDP growth reflects actual changes in output, which is why it is the preferred measure for comparing economic performance over time.²

Per capita growth

GDP per capita divides a country's total economic output by its population, making it a closer proxy for living standards than headline GDP growth alone. But it has limits. As the IMF notes, GDP per capita does not capture things that matter for well-being, such as environmental damage, the reduction of leisure time, or how income is distributed across the population. A country can show strong per capita growth while inequality widens or natural resources are depleted.^{2, 12}

Compound annual growth rate

The compound annual growth rate, or CAGR, gives a single number to summarize average growth over several years. Rather than averaging annual growth rates, it uses the principle of compounding. The formula is (GDPₙ / GDP₀)^(1/n) − 1, where GDP₀ is the starting value, GDPₙ is the ending value, and n is the number of years.¹³

The result is the constant annual growth rate that would be required to get from one value to the other over that period. Economists typically calculate CAGR over long periods such as decades, making it useful for comparing growth performance across countries or identifying whether a recent growth rate is above or below a country's long-term average.¹³

Simon Kuznets, who received the Nobel Prize in 1971 for his empirical research on economic growth, also developed foundational methods for measuring national income that made these calculations possible.¹⁴

Even so, GDP has well-known limits as a measure of overall welfare. As the IMF notes, GDP per capita does not capture things like environmental costs, the depletion of natural resources, or how income is distributed within a country, which is why bodies like the UN supplement it with measures such as the Human Development Index.²

Sustained economic growth rarely comes from a single policy. Research across several decades has identified a set of conditions that countries making the fastest progress tend to get right together.

Physical capital and infrastructure

Infrastructure such as roads, power grids, and digital networks helps economies grow by reducing the cost of doing business and connecting producers to markets. Public investment is especially important here because the benefits are often too broadly shared to attract private capital alone.^{15, 16} A new port or highway, for example, may benefit thousands of businesses across a region without any single one bearing the cost of building it.

Human capital

Education, vocational training, and public health raise worker productivity and expand the pool of people able to absorb new technologies. The World Bank's Human Capital Project, which works with 95 countries and whose Human Capital Index covers around 98 percent of the world's population, identifies investment in people through health, nutrition, education, and skills as one of the most consistently documented drivers of sustained growth.¹⁷

Innovation and technology

New ideas are the fuel of long-run growth, as Romer's research made clear.⁸ Research and development, together with well-designed patent systems, are the main ways economies produce and protect those ideas, balancing the incentive to innovate with the ability for others to build on what already exists. When knowledge spills over from one firm or sector to another, which it often does, the benefits of a single investment can ripple across the entire economy.⁵

Institutions

Good institutions make investment worthwhile. As the 2024 Nobel committee summarised the laureates' work, societies with inclusive political and economic systems tend to generate long-term prosperity, while those with extractive institutions that concentrate gains in a small elite struggle to sustain growth.⁶ Acemoglu, Johnson, and Robinson argue that the quality of institutions is one of the most important explanations for why some countries are far richer than others, particularly when tracing differences back to the colonial period.¹⁸

Trade and openness

No economy grows in isolation. Access to foreign markets for exports and imports has been shown to raise productivity through economies of scale, competition, technology diffusion, and innovation. A 2024 review of recent evidence in the World Bank Research Observer (Irwin, 2024) found that unilateral trade reforms in developing economies have boosted economic growth by 1 to 1.5 percentage points on average, a difference that compounds over decades.¹⁹

Macroeconomic stability

Long-term investment requires a stable environment.²⁰ High or erratic inflation, weak public finances, and poorly supervised financial systems make that difficult by introducing uncertainty into decisions that are meant to pay off over years or decades. Stable macroeconomic conditions do not generate growth on their own, but without them, the other drivers of growth struggle to take hold.²¹

Growth is not a single thing. It is capital, technology, institutions, and people, working together over long periods of time. What the laureates' research makes clear is that none of these can fully substitute for the others.

A country can accumulate capital without technology to make it productive. It can generate ideas without institutions to let them spread. The economies that sustain growth over generations tend to be the ones that figure out how to get all of it working at once.

For insights into economic growth and related fields by Paul Romer, Daron Acemoglu, and other Nobel laureates, visit Nobel Perspectives & Economic Views.

Roser M.What is economic growth? And why is it so important? Our World in Data, 2021.
International Monetary Fund.Gross domestic product: An economy's all. Finance & Development, 2024.
Kaihatsu S, Koga M, Sakata T, Hara N.Interaction between business cycles and economic growth. Bank of Japan Working Paper Series, 2018.
Nobel Prize Outreach.Press release. NobelPrize.org, 1987.
Nobel Prize Outreach.Popular information. NobelPrize.org, 2018.
Nobel Prize Outreach.Press release. NobelPrize.org, 2024.
Solow RM.A contribution to the theory of economic growth. The Quarterly Journal of Economics, 1956.
Romer PM.Endogenous technological change. Journal of Political Economy, 1990.
Nobel Prize Outreach.Popular science background: Their research helps us understand why some countries are rich and others poor. NobelPrize.org, 2024.
Rostow WW.The five stages of growth: A summary. Cambridge University Press, 1960.
Investopedia.Real economic growth rate: Definition, calculation, and uses. Investopedia, 2024.
Investopedia.Per capita: What it means, how it's determined, examples. Investopedia, 2024.
The CORE Team.Measuring economic growth. The Economy, 2017.
Nobel Prize Outreach.Simon Kuznets: Facts. NobelPrize.org, 1971.
International Monetary Fund.Making public investment more efficient. International Monetary Fund, 2015.
International Monetary Fund.Well spent: How strong infrastructure governance can end waste in public investment. International Monetary Fund, 2020.
World Bank.The Human Capital Project: Frequently asked questions. World Bank, 2024.
Acemoglu D, Johnson S, Robinson JA.The colonial origins of comparative development: An empirical investigation. American Economic Review, 2001.
Centre for Economic Policy Research.Trade and inclusiveness. VoxEU, 2018.
World Trade Organization.Trade, technology and jobs. World Trade Organization, 2017.
International Monetary Fund.Structural reforms and macroeconomic performance: Country cases. International Monetary Fund, 2015.

Skip Links

Search Title

What is economic growth?