Something we all need to understand is that a growing economy isn’t a static economy. Well, put like that, I’ve just made a statement of the blindingly obvious of course – something that is growing isn’t staying the same, is it?
But there is more here than just being tautologous. A growing economy means that relationships change between varied economic numbers at the same time as those numbers for incomes, GDP, and so on, all generally rise.
To give just one example, spending upon luxury goods will rise as incomes rise. We will spend less of our income upon, say, rice and more upon, say, life insurance as we get richer. That is entirely tautologous in the usual economic jargon, as luxury goods are those that we spend higher portions of our income upon as we become richer. Rice is usually thought of as an inferior good, we spend less upon it as we get richer, insurance as a luxury one.
My point though is that a richer country will have not just larger amounts in the same proportion spent upon the two items, the proportions and relationships will change too.
This doesn’t matter very much but the same basic point -- growth will change ratios between different statistics – does matter. For example, we’ve a complaint from certain analysts that the GDP growth figures for Bangladesh don’t add up.
The government’s trumpeting – rightly, it’s a good number – 7.65% growth. By definition, GDP equals all incomes for everyone in the country, meaning that we are all collectively richer – a good thing, the very point of our having an economy in the first place.
The analysts are arguing that if growth is to be at this level then investment needs to be at another – they say 34.85 % of GDP. That is, to make the growth happen we can only consume 65.15% of everything we make, the rest must be invested in producing the next burst of growth. But that investment is only 31.47%, so the growth figure either is wrong or cannot be maintained.
This suffers from a number of problems including the most basic, that economic numbers simply aren’t accurate to this level of detail. We know we make mistakes in GDP calculations, we’re entirely positive there are huge holes in investment numbers. They’re to be used as guides to direction rather than anything else.
But there’s a theoretical, rather than practical, problem here too. Two in fact.
Imagine that we did get the higher growth with less investment? Suppose it did happen, just as a mind experiment. What would that mean?
It would mean that we’re becoming more productive. We need less capital investment in order to produce a unit of growth – the very definition of our being more productive. We should also note that being more productive is the very definition of economic growth itself. So, we grow, we become more productive at the same time, this seems reasonable enough. It would also be fine, fine news.
That deeper problem with the claimed idea though is that as an economy grows, we do know that these relationships are going to change. Also, a technology changes, so also, is this specific relationship going to change.
Think on growth itself, we can achieve this by using more inputs into the technologies we know. We can have more people digging fields, more people in garment factories, buy more machines to use with either. Or we can change the technologies we use to do things, become more productive users of machines, or labour, cotton, copper, or cement even.
If we’re achieving our growth through more inputs, including using more capital, then yes, that relationship between capital investment and growth will remain constant. But if we’re gaining our growth from that second method, using resources more efficiently, then it won’t.
That second is also called “total factor productivity” and a useful finding about the 20th century was that some 80% of the growth in the free market economies came from TFP improvements. In the socialist, planned, economies, none did, all growth was achieved by using more inputs.
Bangladesh is a lot less socialist than it was, a great deal more free market today; we’d expect to have moved from increased-input-only growth to increased-productivity growth – meaning that our relationship between investment and growth isn’t static, isn’t a constant.
Do note that this doesn’t mean that more investment wouldn’t make the growth rate faster again. It’s only that we shouldn’t expect these ratios to stay constant as the economy grows, therefore we cannot say that a falling investment-to-GDP ratio will kill off that GDP growth.
One of the canonical stories about how economic growth happens in the modern age concerns sardine fishermen off the coast of Karnataka. They could not afford boat-to-boat radios and so roamed the ocean near randomly looking for fish. And landed what they caught at ports that might be oversupplied, while others in the area had shortages – and therefore higher prices.
Mobile phones changed that, leading to lower prices to consumers, higher profits for fishermen, the two making up pure efficiency gains, the finest kind of economic growth we know of. The fishermen spend a few hundred US dollars on enough phones to make this happen, thousands upon thousands of dollars worth of repeating higher incomes, that economic growth.
The new technology lowered the costs, the investment required, to catch the fish. This of course plays merry havoc with any calculations of the amount of increase required in capital investment to produce economic growth, doesn’t it?
And to repeat, in a market economy, the great bulk of economic growth is going to come from these sorts of productivity improvements, those that don’t require the use of more inputs, but instead the use of those already available more efficiently.
It’s therefore not just that we should cast a wary eye at those trying to use such detailed economic numbers. It’s the very fact that we’ve a growing and more productive economy, which means that we cannot rely – and shouldn’t – upon past relationships between economic numbers to predict or plan the future. Because a growing economy just isn’t static in any form at all. l
Tim Worstall is a Senior Fellow at the Adam Smith Institute in London.