Monday, 1 February 2016

Economics Might Be Very Wrong About Growth

In World Economy News 01/02/2016

Has the world entered a period in which economies simply won’t grow at the rate they once did? Radical as the thought may seem, it might not be radical enough.
A few years ago, the economist Larry Summers stirred much debate when he suggested that the anemic growth of recent years might not be just a temporary affliction, and might have little to do with the 2008 financial crisis. Instead, he surmised, it could reflect secular stagnation — a new normal of low consumption and lagging growth stemming from accumulated household debts and rising inequality, among other factors. In different terms, considering the impacts of technological innovations, economist Robert Gordon has been arguing for much the same conclusion.
For two decades now, a lesser-known group of mostly German economists has been making a more extreme argument: that the standard model of exponential growth — in which an economy can be expected to expand by a given percent every year, no matter how big it gets — is fundamentally flawed. Rather, these economists claim that while exponential growth fits some young economies, mature economies tend, as a rule, to grow much more slowly — in a linear way, meaning that the percentage growth rate would constantly decline.
The latter view has gained support from a new study, in which a team of European economists and statisticians looked at data on the economic development of 18 mature economies, including the U.S. and most major European nations, from 1960 to 2013 (they started at 1960 to avoid the effects of World War II). They found that the data on growth in gross domestic product per capita fit best, statistically speaking, with a linear model. For only two countries did the exponential work better, and then only barely. In other words, linear growth — in which mature economies add less new activity (in per capita, percentage terms) each year — is the empirical norm.
If the finding holds up, then today’s economics may stand in need of some serious conceptual change. As the authors of the new study note, an awful lot of conventional economic analysis rests on the unquestioned assumption of exponential growth. Governments, for example, rely on it when they decide how much money they need in their social security funds, or when summing up the costs and benefits of any proposed project, including measures to mitigate climate change. If growth isn’t exponential, the discounting procedures used habitually in such analyses make no sense at all, and standard economics systematically undervalues the future.
Moreover, the idea of exponential growth rests at the core of essentially all modern theories of growth – theories purporting to explain how capital, labor and technology combine to increase productivity. How valuable can such concepts be if they don’t even get the basic observed pattern of growth right?
Perhaps Summers and Gordon are correct that the fast growth seen over the past couple centuries was a unique, unparalleled episode, and that future growth will be much slower. Although the new study doesn’t get into the specific drivers of linear growth, it’s consistent with their conclusion.
Paradoxically, a slowing trend could actually be good news, even if humans will have difficulty getting used to it. Due to explosive growth, it will soon take nearly two planet Earths to support the world population sustainably at average resource-consumption levels. We don’t actually have two Earths, so growth should probably slow. If it’s already doing so, that may actually be a relief.

Source: Bloomberg View