Growth: the deeper questions

Today first estimates of the UK’s final quarter GDP show that the economy shrank by 0.3%. There will be a lot of posturing around this but it doesn’t mean that much. GDP is not a direct measure of wellbeing (unlike unemployment, for example), and it isn’t that clear how one quarter’s statistics have a bearing on people’s day to day lives. Besides these early estimates are not very reliable. Still these GDP figures do prompt some wider questions.

The first is about short-term economic strategy. A large number of government critics, loosely referred to as “Keynesians” though no professional economist would accept that label, say that a series of poor GDP returns reflect a failure of economic management. Firstly that cutting government expenditure reduces demand, which has a multiplier effect to shrink the economy as a whole. Second that the government should in fact be doing the opposite: using fiscal policy to use the same multiplier effect to boost the economy at large. I don’t intend to discuss this much further today, except to make this point. These arguments have weight because the UK economy is in recession, with high unemployment. This means, or should mean, that there is slack. Slack is usually inefficient, especially when unemployment is involved, and evidence that the slack is being taken up would come from better GDP growth figures. But what people are talking about is a short-term effect: once the slack is taken up the economy bumps into more substantive constraints and “Keynesian” stimulus would have undesirable effects, such as inflation or an unsustainable trade deficit. But what are the prospects for growth in the longer term, and does it matter?

There is now quite widespread pessimism about the long term prospects for growth in the UK and other developed economies. Mostly this is ephemeral. People assume that current trends simply continue; a few quarters of stronger growth and the mood will lift, even if this says nothing about longer term prospects. But more serious questions are being posed. Mostly these are based on demographics – the aging of the baby boom generation – and an allegedly slowing pace of innovation. The Economist had an interesting article on the latter a couple of weeks ago. This explained the reasons why people are becoming pessimistic – but then pointed to reasons for counterbalancing optimism. I think The Economist is right as far it goes: innovation picks up in some areas just as it slows in others. But they miss an important wider question about the role of economics itself. They too easily assume that innovation will lead to increased productivity and this to growth, in accordance with conventional economics. I think this may be breaking down.

Try to think about this in terms of three ways in which economic wellbeing advances. First is the conventional consumption which dominates economists’ thought. People consume more goods and services, and the economy is able to deliver these because productivity rises. Second is the consumption of what I would describe as personal goods and services. This superficially resembles the first sort of consumption, but the very nature of these goods and services is that productivity cannot grow. Think about personal therapy – shorter sessions or sharing sessions with more people undermines the product we want to buy. Another example is status goods – often the whole point is to show status by buying goods or services that are produced at low productivity. And finally people may opt out of the conventional economy altogether: take time off, pursue hobbies and so on.

So what if people direct their energies (and use innovation) to consuming personal goods and/or opting out, rather than consuming conventional goods? Economic wellbeing advances but GDP growth does not; in the case of opting out, GDP actually shrinks. Economists tend to be very dismissive of this, and try to assume their way out the problem: in particular that than economy advances on all three fronts at once, so that conventional consumption is representative of the whole. This has worked well enough for the “opt out” option: I am assured that there is good evidence that leisure increases alongside consumption, not in opposition to it. But there is a logical problem with the advance of personal goods, and economists have a name for it: Baumol’s disease, after the economist who pointed it out. The more productivity advances on conventional goods, the higher share of the economy is taken up with personal goods – and you have to work that much harder to improve productivity on conventional goods to achieve the same level of growth. Economists may have named it, but they still usually ignore it and its implications. They usually just have a quick moan that we should spend more energy trying to improve the productivity of services (the problem is usually defined in terms of agriculture, manufacturing and services – with what I am calling personal goods being part of services).

But I think the whole balance is shifting. There are limits to the extent that people will want to improve wellbeing by simply consuming more mass-produced goods and services. An increasing proportion of the population has reached that limit (I certainly have), instead increasing leisure or buying “quality” (lower productivity) goods. And look at innovation. I consider my smartphone to be a fantastic technical advance that has improved my life a lot. But has it helped the conventional economy by helping me to produce more services for other people to consume? It hasn’t. Quite apart from the demographic issue, which is real enough (and you could say this is actually the same thing, with people choosing more leisure by retiring for longer and consuming more personal services through hospital and other care), the rate of conventional economic growth is slowing in the developed world.

Does it matter? After all economic wellbeing may still progress. Unfortunately there are two reasons that it may: debt and taxes. These two lie at the very heart and purpose of the conventional economy. Debt and credit tend to get washed away in a high growth economy – but it will get increasingly difficult for people, businesses and governments to service past debts in a low growth environment. And a lot of the personal services that take up a higher and higher proportion of our economy (like health) are funded through taxes, as well as support for leisure (pensions) – and yet if the conventional economy does not grow this will bulk larger.

Debt and taxes. These issues are destined to dominate developed world politics in the century to come.