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Economic growth

Economic growth

We manage what we measure, and what we measure of economic growth is but a tiny part of our overall activities, of what we damage as well as what we make; and it reflects only a subset of what we want from our lives. 'Economic growth' is, therefore, rather a poor indicator of well-being: rather, it is a component of something larger, on which it relies.

This section is, therefore, concerned with two fundamental issues. First, we measure and are concerned by economic growth, but few pretend that this maps directly onto 'quality of life'. We consider what economic measures capture and what they do not, and consider some alternative approaches which may grow in importance.

Second, and with these thoughts in mind, we consider the factors which set long terms economic growth rates. We conclude that these are complex, recursive and as much concerned about how choices are made than which particular choices are selected. There are tight bounds on what it takes to be a complex nation (or a successful company) but within these, there is a wide range of combinations which deliver equivalent results. The magical prescription - if there be such - is, therefore, most likely to be found in the way in which societies and companies make their choices rather than in the ideological, theoretical or pragmatic basis against which they do this. In other words, the means of governance - the institutions, the people involved - define much of the outcome.

Accounting for wealth.

This section is not intended to be a review of the arcana of national accounts. However, some fundamentals. Accounts measure two different things: stocks and flows. However, many things that we feel are important or valuable are not easily measured, and are thus omitted. What we call "GNP" is, therefore, a construct which omits, for example, unpaid labour such as caring and domestic work. If one places one's own litter in a bin, then this is not a part of the GNP, but if one drops it one the street and someone has to pay to pick it up, then it is. The quality of the cleanliness of the streets appears nowhere as a stock, however, and changes in this quality is not reported as a flow. If we acquire more educated people, or pollute our rivers, then this is not reflected in the formal assessment that we make of our wealth.

Economists distinguish private goods (which have an owner) from public goods, which either have no owner or are assigned or protected by the state. These may be market tradable or not, as the table shows. Valuing the other boxes, either as stocks or as flows, presents major issues.

Private goods

Public goods

Market, tradable

Consumer goods

For-pay services
Land and property

Regulatory permission: e.g. pollutants with tradeable permits, building permits, extraction rights.


not tradable

Personal knowledge base and skills

Voluntary service
Unpaid care, domestic work
Leisure activities

Air and water quality

Climate stability
Defence and security
Civil society
Land use management

For an in depth review, please see the US Bureau of Economic Assessment, or - for a 'green focused' approach, consider the SEEA proposals (UN System of Integrated Environmental Accounting.) We, however, look at ways of setting prices on non-traded but valuable items in the closing part of this section.

At issue is, however, less how this is done than why it should be done. Comprehensive accounts contribute to a better understanding of the functioning of the economy and of the interaction between the economy and the natural environment. Businesses and governments need and want to know about basic market conditions in the world, the nation, and their region. Without good market and non-market information, firms and policy makers have no map to guide them. However, the US - and other industrial nations - spend enormous sums on pollution abatement, crime control and the like, but with no corresponding signal or increased wealth appearing in the accounting structure. Indeed, allocation of resources proceeds on political grounds as much as it does rational ones, particularly in the absence of a unified approach to valuation of non-market goods and intangibles.

If we are to measure progress in ways that reflect the things which mater to us, then how is this to be done? First, what are we to include; and second, how are we to bring this collection of apples and pears into a common framework of measurement?

What we include is an issue which is bound to be political and there can be no objective way of identifying candidates that does not raise exactly the issues of measurement which the accounting is intended to allay. However, environmental, infrastructural resources are clearly candidate elements of this, as are human capital, political maturity and knowledge. Cultural issues, the value of intangible networks and issues such as brand, reputation and the like are very much harder to quantify than these.

How are these candidates to measured against a common background. With difficulty. There is seldom absolute objectivity about the things to be measured, but having statistics on - for example - the amount of science done to a given level of quality translates weakly into purely financial terms: after all, there is no market for - let us say - the Danish science base as an entity.

Accountants are experimenting with four main approaches to these issues. These are the hedonic, contingent, dose response and travel cost models. As these are likely to assume much greater importance to company, as well as national accounts, it may be helpful to explain what they entail.

Hedonic methods use a bundle of similar entities in order to establish the statistical properties of market transactions related to their use. A car can be considered as a bundle of attributes: it has speed, reliability and so forth, and statistical techniques allow one to say what part of the overall value consumer assign to any one of these. An unpriced entity can therefore be valued as a cluster of attributes, with the contributory values obtained from elsewhere. (Similar things are, of course, done to value conglomerate companies with regard to sectoral risk and return.) The "travel cost" method is a specific example of the hedonic approach which focuses on how much it costs a consumer to use facilities, and then to value an unpriced facility by correlations with how much it costs consumers to get to it and enjoy its use.

Contingent value methods ask people directly what they would pay for a good or service, often by asking them what good of known value (a car, a meal in a restaurant) that they would be prepared to trade for it. Applications in the area of environment and natural resources include, for example, asking individuals what they would be willing to pay to reduce smog, to increase visibility in places such as the front range of Colorado, and to clean up an oil spill in a coastal area. While widely used, this approach has the standard problems associated with surveys. People tell the surveyor what they think they want to hear, or they aggrandise themselves. The key is, as ever, to make the questions concrete and focused, rather than generic.

The dose-response method starts from objective measures of the response of the public (or a good, such as forests) to positive measures and negative features, such as damage to human health resulting from exposure to a pollutant. As the costs of this impact are relatively easy to estimate, a cost or benefit can be assigned to the issue.

The US Bureau of Economic Accounting says of these approaches: "The overriding problem with all these methods is that they require voluminous data and statistical analysis and can hardly be used routinely for a large number of products in constructing environmental accounts."

The fundamentals of growth.

The past century has seen unprecedented economic change. All of the economic output of the world in 1900 occurs in about two working weeks in 2000, will fit into about one week in 2015 and two working days in 2020. Seen against the perspective of history, what has occurred is extraordinary and unprecedented. Figure 1 shows English inflation since 1265. (Note the logarithmic scale on this chart).

Figure 1: English inflation, showing recent unprecedented change.

Similar figures for crop yields, information exchange, education and trade all demonstrate the same explosive change. Economic balances have changed sharply, from farming and simple manufacture to complex integration and the service economy, as figure 2 suggests.

Figure 2: Formerly dominant sectors - railways - have virtually vanished from the interest of capital markets.

Many other changes have occurred. It is the business of economics and social science to identify why this has happened.

The economic model has been endlessly complicated. However, there seem to be three fundamental ideas which underpin the issue:

Output= The stock of productive assets times the effectiveness with which they are used. The stock of assets is, of course, the accumulated surpluses that have been distributed less the attrition rate that the stock suffers.
Surplus= Output plus borrowing minus consumption, stock replacement, debt repayment and losses.
Effectiveness= A complex function of:
  • Information symmetry (about overall goals - as in the previous section - and about individual performance, new possibilities and general choice.)
  • The innate quality of the stock of productive assets.
  • The capacity to transform concepts into new ways of performing old tasks or into completely new kinds of output. Two central sources of such concepts have been science and mass organisation.
  • The level of reward as compared to the prevalent level of risk and uncertainty.
These features have strong non-linear relations - they affect each other. The pace at which established positions are eroded is affected by all of these features, for example, but itself accelerates or sharpens the intensity with which they operate.

Most policy debates tend to revolve around these variables. Ultimately, however, the economic argument comes down to this: effective use of resource provokes growth, and effectiveness comes from knowing what you are about, having the resources that you need and an operating environment which is conducive to making use of them. More capable people - for example - or more saving add to the stock and quality of assets, but are not of themselves enough. What is needed is a balance, and machinery through which this balance can operate. Markets, as the conduits of information and competitive imperatives, are seen as the invisible hand that creates just such a balance.

Figure 3: Inputs of capital and labour, and the resulting growth rates.

Total factor productivity - efficiency - has some linkage with the overall growth that is achieved. Africa has become less effective since 1960 in using its assets and has grown relatively little. Asian Tigers have been effective and have grown. However, the relationship is far from a direct one, and we have to look elsewhere for a fuller explanation.

Historians and social scientists do not necessarily disagree with this perspective, but point to much broader instances where effectiveness is created. Markets cannot easily handle public goods, for example, and what is the stock of national capabilities if not a public good? In an age of virtually universal mass education amongst the industrial nations, is it markets of social and political processes which are setting this context? To the invisible hand of the market is added the 'other hand' which is social organisation.

Countries show extraordinarily consistent growth rates over very long periods, as indicated in Figure 4. Britain has averaged 2% economic growth for over 100 years, the US something over 3%. Britain moved down from being a trade-focused superpower, the US shifted from agriculture and early mass manufacture to become the sole superpower. Very little remained constant, as Figures 1 and 2 suggest. Indeed, the habits of life and the general institutional structure are the sole survivors of this transition.

Figure 4: Remarkably consistent rates of growth characterise over a century of fast change.

Much the same is true of other nations which have not felt defeat in war, which show equally regular patterns, disturbed only by the mid-century depression. Even more remarkably, those which did suffer invasion and mass destruction show a common pattern: a constant rate of growth, punctuated by collapse, a phase of fast growth to catch up, and then a settling-down on the rate with which they were accustomed.

Figure 5: War destruction if followed by 'economic miracles', but then original underlying rate of growth asserts itself.

Economic miracles may, indeed, consist of recapitulating past successes, perhaps whilst avoiding the unhappy experiences encountered the first time around. It took Britain 60 years to double output in the run-up to industrialisation, but China only 10 years to do the same. It would be idle to assume that China learned nothing from the successes and failures of the rest of the world when it was doing this. However, China's growth was also the decompression that occurred after the internal war and destruction of the Cultural Revolution. Subsequently, other constraints have imposed themselves and growth has slowed, perhaps to what history should have led us to expect.

The 'social' model of growth suggest that there are three fundamental pillar to progress. One of these is identical with the economic model. The second is concerned with our capacity to organise ourselves, the most obvious feature of which are our institutions. Third, however, is a force sometimes called 'social capital', which an be a misleading term. What is intended by this is the pattern of tacit order by which societies operate: the habits that the exhibit and their preferences, their amicability and means of informal conflict resolution, what they aspire to and how they have fun: what we want for our children, and how we live most of our individual lives. We shall discuss what this is in more detail, in the section that is concerned with political institutions.

Figure 6: Three pillars of progress.

If these three pillar support events, then it is the interaction between them which sets the potential pace of change. Countries which are early in the development process have, by definition, simple if robust structures in place. Complex economies need complex societies and institutions, but complex societies need complex economies just as much, as well as the means to organise themselves. There is an interaction which defines the central column on Figure 5, where development and growth proceed in balanced partnership.

This perspective suggests that 'economic growth' is the outward manifestation of something much more complex, which is the growth of useful complexity. Measuring this is problematic, as we have seen. Finding one's way through the tangled thicket of complexity may be an increasingly important task for individuals, companies, economies and nations. Failure to evolve the necessary tools and to create an evolving consensus may halt growth just as surely as economic failure impedes political modernisation.

The issues and the potential of the next few decades will propel the industrial nations onto unsure or unknown terrain on all three of these axes. Economic change is leading the way. Social change is grudgingly keeping pace, but demographic and other factors may reverse this. Institutional change is, however, the slowest of all to alter and we face a new millennium with political structures which are based on ill-concealed prototypes two hundred years old.

The US constitution was invented for and by oligarchical land owners. Adult free male suffrage was countered by electoral colleges packed with grandees. Slaves and women were not to vote. Times have changed, but the structure is still there, broadly unquestioned.

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