"Arguing in My Spare Time," No. 5.01
by Arnold Kling
January 20, 2002
Ultimately, long-run economic growth is the most important aspect of how the economy performs. Two major factors determine the prosperity and growth of an economy: the pace of technological advance and the capital intensity of the economy. Policies that accelerate innovation or that boost investment to raise capital intensity accelerate economic growth. -- Brad DeLong, Macroeconomics, p. 89
This essay describes what one might call the Growth Doctrine. This doctrine states that the cumulative effects of economic growth over time are large. It states that the differences in wealth across countries are due to differences in cumulative economic growth, rather than to class conflict or environmental destruction. It states that the ability to deploy know-how and investment are the determinants of growth. And it states that economic policy will affect the well-being of a population primarily on the basis of its effect on economic growth.
If average per capita income in the world was about $150 in the year 1 AD and it is about $8200 today, then what was it in the year 1800?(A) $250
The answer, according to a table on page 120 in DeLong's text, is that just two hundred years ago, average per capita income was only $250 by today's standards. In 1800, many people, if not most, were no better off than their ancient ancestors.
Thus, economic growth as we know it is a relatively recent phenomenon. It is gradual, however. Taking out population growth and inflation, in the twentieth century income grew at "only" 2-1/4 percent per year, which is more than twice as fast as in any previous century. Growth at a rate of 2-1/4 percent per year, with the power of compounding, has enormous cumulative effects. It raised income by nearly a factor of 10 over 100 years, meaning that on average we enjoy a standard of living that is 10 times as high as that of people who lived 100 years ago.
Here are some specific indicators of the cumulative effects of increases in know-how and capital:
According to Ward Nicholson, around the time of Christ, the average height of males was 171.9 centimeters and the average lifespan was 41.9 years. In 1400-1800, these figures were 172.2 centimeters and 33.9 years, respectively. Today, the figures are 174.2 centimeters and 71.0 years, respectively.
According to DeLong (p. 440-441), around the time of Christ, at least 90 percent of the populace had to be employed in agriculture in order to produce enough food. By 1800, this proportion still was over 50 percent. In the United States today, the proportion stands at around 2 percent.
According to Niall Ferguson (The Cash Nexus, p. 34, "between the seventeenth and twentieth century, the capacity of war to kill rose by roughly a factor of 800."
According to data cited in this paper by DeLong, the conversion from steam engines to electric motors helped to increase the total mechanical power in the United States by a factor of 40 in the seventy years from 1869 to 1939.
In the article cited above, DeLong notes that the exponential increase in the instructions performed per second by a computer chip, along with the growth in the number of computers, implies a million-fold increase in total computational power in the last forty years.
Projecting this trend into the future, Ray Kurzweil makes this astonishing claim (The Age of Spiritual Machines, p.3):
our most advanced computers are still simpler than the human brain--currently about a million times simpler (give or take two orders of magnitude depending on the assumptions used). But...Computers...are now doubling in speed every twelve months. This trend will continue, with computers achieving the memory capacity and computing speed of the human brain around the year 2020.
Another important fact of economic growth is that the rate has differed considerably across countries. DeLong (p. 142) uses the example of Argentina vs. Norway. Since 1900, Argentina's income per capita has grown by a factor of three, while Norway's grew by a factor of nine.
The growth docrine says that the differences in the standard of living across time and across countries are due to differences in economic growth. We are wealthier than our great-grandparents because of the cumulative effects of economic growth. We in the United States are wealthier than people living in much of the rest of the world because of the cumulative effects of faster economic growth.
It may seem obvious that our wealth is due to economic growth. However, there are at least two popular alternative notions.
One notion is that total wealth in the world is fixed. This means that one individual or group can increase wealth only at the expense of some other individual or group. To borrow the jargon of game theory, wealth is a zero-sum game. Marxists and others who view wealth in terms of class conflict seem to hold this view.
The class conflict model is very powerful from a moral perspective. It says that the poor are victims of the rich, who are villains.The difficulty with the class-conflict alternative is that it does a very poor job of explaining the main facts about growth and relative wealth. For example, it does not explain why we are so wealthy in comparison with our ancestors. It makes little sense to say that we are exploiting and impoverishing our ancestors.
Marxist zero-sum proponents prefer to focus on the contrast between wealth in the West and poverty elsewhere. However, it is difficult to tell a story that explains these differences primarily in terms of Western exploitation of other countries. There is no plausible way to explain Western wealth as something stolen from Africa or Latin America.
Another notion comes from the environmentalists. According to their theory, wealth comes from exploiting natural resources. Because natural resources are fixed, our enjoyment now will come at the expense of a catastrophe in the future.
Economists call this view Malthusianism. That is because Thomas Malthus first suggested that population growth would lead to over-utilization of the best land, which in turn would keep average income from increasing.
According to the neo-Malthusians, we are playing a zero-sum game against the environment. If we use up precious natural resources now, we will have to lower our standard of living later.
Not all economists dispute the environmental pessimists. Those that do, however, point out that the usage of natural resources is governed by prices. The trend over time seems to be for natural resources to be used more efficiently, leading to a decline in the relative prices of commodities.
The environmentalist argument about limited natural resources was most popular during the "energy crisis" of the 1970's. Since that time, the energy intensity of GDP has declined, and the "energy crisis" eased.
Economists in the optimistic camp argue that innovation and technological advance help to create the conditions for sustainable growth. As long as natural resources are governed by property rights and prices, the market will find ways to side-step the doomsday scenarios.
Economists account for growth on the basis of two factors, only one of which is measured fairly directly. The measured factor is capital intensity--the deployment of machinery and physical structures to enhance the productivity of workers. The other factor is somewhat of a grab-bag of everything else that might explain differences in productivity over time or across countries. This other factor, sometimes called the "Solow residual," probably includes scientific knowledge, education, institutional adaptability, and social customs. The trend among economists over the past half century has been to increase our estimate of the relative importance of this residual factor, which one might call technology adoption.
DeLong (p. 139) suggests that about half of the difference in per capita income between the United States and poor countries can be accounted for by the measured factor of capital intensity. Stephen L. Parente and Edward Prescott, in Barriers to Riches, believe that capital intensity accounts for even less of the difference. They point out that output levels between the richest and the poorest countries differ by a factor of 20, and the rich countries would need a savings rate 8000 times that of the poorer countries in order to account for this. In fact, the savings rates in poor countries and rich countries are not terribly different.
Over the past decade, the United States has enjoyed more cumulative economic growth than many other highly-developed countries. Some of this higher growth has been due to a boom in investment. But some of it also appears to be due to the greater ability of our economy to adapt new technology. Our laws and business practices make it easier for companies to change business processes and for workers to be re-allocated out of inefficient firms and industries. Japan and many European countries have been relatively inflexible by comparison.
What is your biggest policy concern:
Ten years from now, the outlook for these issues will be brighter if economic growth averages over 2 percent than if economic growth averages less than 1 percent. If we have more growth, then the poor will enjoy a higher standard of living, social security will be solvent, and our ability to maintain clean air and water will be greater.
The Growth Doctrine, like Free Trade, is adhered to by economists of both major political parties. However, the Growth Doctrine does not yet have much impact on policy discussions.
According to the Growth Doctrine, the appropriate way to evaluate issues such as long-term tax policy or social security reform is by focusing on how such policies affect economic growth. That is not what happens today. Most of the political heat about these policies is not focused in terms of long-term economic growth. Tax policy is debated in terms of who "deserves" a tax cut. Social security is debated in terms of arcane accounting shell games. This is not to say that the Growth Doctrine favors Republican or Democratic economic policy. Rather, we should lament the fact that neither side appeals to the Growth Doctrine to support its positions.