If you follow the news at all in these turbulent times, you’ve certainly heard the endless talk about economic growth. In order to get elected, politicians must promise it; in order to get ratings, journalists must talk about it; and in order to get tenure, economists must study it. Economic growth will apparently fix every crisis and cure every ailment. It’s like a vitamin supplement ad on youtube — whatever you have, it will fix. Important government initiatives are cancelled if there’s a suggestion that economic growth will be impacted. Other initiatives are started that seemingly have no benefit, other than to trigger economic growth.
But is this really correct? Measuring the economy is certainly important. The federal reserve needs to set interest rates and control the money supply, and to do that they need reliable indicators of economic activity. Economic growth, or more precisely, growth in GDP, is one of the metrics they use. But why is economic growth important for the rest of us? Why do we hang onto every word the talking heads tell us? The truth is, we shouldn’t. It turns out that economic growth does not do a good job of measuring increases in wealth. In this article you will see many examples of this. Sometimes economic growth is large, but there is almost no increase in wealth. At other times, economic growth is non-existent, but increases in wealth are substantial. Economic growth turns out to be a metric that is useful for economists, but can safely be ignored by the rest of us.
Our current system for measuring the economy was devised by Simon Kuznets. In the 1930’s, with the nation in a deep depression, the federal government realized it had no idea how much the nation was producing. With no way to measure it, there could be no way of determining if progress was being made. Kuznets was asked to devise a method to measure it. In some ways the metric was pretty arbitrary. Kuznets didn’t want to include alcohol sales — he didn’t approve of drinking. Given how little we feel like working after having a few drinks, maybe this makes sense. On this he was overruled, but economic growth does not include the sale of marijuana, or prostitution. Think about this for a while and you’ll realize how arbitrary the whole measurement is. Despite these inconsistencies, economic growth does tell us roughly how much the amount of goods and services is changing over time. This is an important piece of information for government economists. But there are may reasons why an economy might get larger, without an increase in per capita wealth. In the following sections we discuss four: commodification, population growth, inflation and illness.
Commodification refers to the process of turning something into a commodity. That something could be an obvious thing, like a forest that gets turned into lumber, or it could be something more abstract, like financial loans. In some societies, a complex network of loans is maintained between friends and relatives. Repayment of the loans is assured because of the connections and relationships between all these people. So loans are not a product that show up in any measurement of the economy. In our society, loans are a business, offered by companies who charge money for their services. Loans have been commodified, and the fees will show up in the measurement of the economy. The concept of commodification is important because it results in the economy being larger, and yet it doesn’t necessarily mean that we have more wealth. An illuminating example is bottled water. Drinking water used to be something you got from the kitchen tap. It was free. But thanks to a concerted effort by the beverage industry, drinking water is now a product that must be paid for. The economy is bigger, but we are no better off.
Population growth is another thing that will cause economic growth. If the population increases by 2%, that means 2% more people producing goods, and 2% more people consuming them, so obviously the economy will grow by 2%. But nobody will be any richer. This may seem so obvious that you would expect the metric to be adjusted to eliminate the effects of population growth. Sometimes it is, but surprisingly sometimes it isn’t. Inflation will sometimes be a factor in economic growth. If prices jump by 10% in a year, then that will be reflected as a change in GDP. This figure, known as nominal GDP, is normally adjusted for inflation, to produce what is known as real GDP. However, that adjustment is not always made, meaning some of the reported economic growth could be meaningless.
Illness may also cause economic growth. This may sound surprising. Imagine an illness that is not serious enough to cause worker absenteeism, but is serious enough to need long term medical treatment. Such an illness would not lower economic output — everyone is still working and producing goods, but it could increase the size of the economy if enough money were spent on medications and treatments. In fact, such a disease exists: obesity. Over 40% of Americans are now obese, and require expensive treatment such as cholesterol medications. An enormous diet industry now exists, including billions spent on gyms, guidance and supplements. The percentage of obese Americans is going up every year, which means a certain percent of economic growth is actually caused by people being sick.
There are also many examples where the wealth of a society increases, but there’s no economic growth, or even negative economic growth. Imagine that a scientist discovers a cure for the common cold that only costs a few pennies. Rather than patent it, he publishes the cure on the internet. Overnight, the $16 billion cold medication industry would be wiped out. Productivity would not go up to compensate for this $16 billion loss, because most people don’t take time off work when they have a cold. So there would be lower economic growth because of this cure. There would be an adjustment period, with considerable hardship for people working in the industry, but overall, we would be better off. Eventually, those people would find employment elsewhere, hopefully working on other medications that are needed. At this point, the economy would be back to its former size. So no economic growth and yet increased wealth. More examples are easy to find. Companies no longer build products to last as long as they can — so called built-in obsolescence. If they did, they would sell less, and economic growth would take a hit, even though we would be better off.
So if we can’t rely on economic growth to tell us if we’re getting wealthier, how do we know? Fortunately there are other measures of increasing wealth that we can use instead. Once you think about them, they seem obvious. In the mid 1900’s, when there was fierce competition between the United States and the Soviet Union, the latter would brag about how many tractors they had, and how many potatoes they produced. It seemed amusing, but they were on to something. Manufactured goods are wealth. A nation with a million tractors is richer than a nation with none. This is provided the manufactured goods are useful of course. A nation with a million more video consoles may not necessarily be richer.
Other measurements of increasing wealth are innovation, education and trade agreements. The entrepreneurial nature of American society is an engine of growth and wealth creation. Better medication, safer cars, more efficient accounting systems — are all evidence of increasing wealth. An educated society is wealthier for many reasons. More doctors means better care for the sick. More engineers means more productive machinery, and more scientists means faster innovation. And finally, a trade agreement with a foreign country can make both countries wealthier — more fresh fruits in the winter for a cold country, and perhaps more lumber or minerals going the other way. Some of these increases in wealth just described will show up as an increase in GDP, but others, as noted, will not.
It’s important to note that this article does not advocate a steady state economy. Such an economy does not ever grow or shrink. Economists like Herman Daly developed this notion in the 1970’s. Proponents of steady state economics believe that growth cannot be unlimited, because the earth has limited resources. But GDP is just a number with a dollar sign in front, and as such, it can grow forever. Our use of resources cannot grow forever of course (at least while we still live on planet Earth), but that is a separate notion from GDP growth.
America has been through a rough period. But we live in a resilient and entrepreneurial country. In the next few decades, it’s conceivable that we will get back on track by rebuilding manufacturing and improving our children’s education, resulting in increased living standards for all. If this happens, economic growth will accompany these changes, but won’t be the cause of the increased living standards. So the next time you hear a politician promise economic growth, insist that they promise growth in wealth instead. Demand that they talk about manufacturing, innovation, and education. Our future depends on it.
