The case for economic growth

The NZ Initiative has published an essay arguing the case for economic growth. Now you might think there is no need for a case to be made for it – surely everyone favours it. Well in the forward it is pointed out:

In self-proclaimed intellectual circles, it has long been fashionable to belittle the idea of economic growth. “GDP is not the same as happiness”, some critics of growth will explain. Others will warn that excessive growth could destroy the environment and leave our planet uninhabitable. Others still will warn that the finite nature of our resources does not allow continuous growth in any case.

In fact the Green Party used to explicitly campaign against economic growth. Now, they only do it implicitly.

Hartwich points out:

Economic growth is the driver behind all of these developments because at its core, economic growth is not mainly about the production of more but about the discovery of better (though often it is both). Economic growth helps us to find new and improved ways of combining resources. The outcomes could be a new medicine, a faster way of travelling, a healthier way of eating or a better way of learning.

The authors first look back at history:

Current measures of international poverty focus on dollar-a-day or two-dollar per-day thresholds. For all but about 0.02% of history, world per capita GDP was just over 50 cents per day, as shown in the graph above. Real economic growth as we now understand it – regular improvements in each person’s quality of life such that we can all readily see how our lives are better than those of our grandparents and great grandparents – is a recent phenomenon. Economic growth of this sort took off only from about 1820.

In the days before economic growth, everyone was below the poverty line!

While Gross Domestic Product (GDP) is hardly a perfect measure of any of the things we care about, the things we do care about are linked to GDP. Higher per capita GDP is associated with better health, wealth, happiness, opportunity, leisure and luxury. Richer societies are also better able to prepare for unforeseen calamities, from new diseases to natural disasters.

GDP is indeed not a measure of happiness, but richer societies can invest more in what does make them happy.

This first-worse-then-better U-shaped relationship between economic growth and environmental quality is called the Environmental Kuznets Curve. The curve was first described in 1991 by economists Gene Grossman and Alan Krueger, who wanted to test whether free trade between Mexico and the United States was likely to worsen or improve environmental quality in Mexico.46 Trade opponents argued that American industrialists would set up factories in Mexico to take advantage of less restrictive environmental regulations, exporting pollution. Grossman and Krueger argued instead that free trade would increase incomes in Mexico and consequently reduce pollution. Grossman and Krueger found that when per capita GDP reached US$4,000– $5,000 in 1985 dollars, or about US$10,000 today, sulphur dioxide and smoke levels started improving with economic growth rather than worsening. Mexican per capita GDP rose in real terms from about US$4,000 in 1992 to about US$10,000 in 2013. In 2010, a Washington Post headline announced: ‘Mexico City Drastically Reduced Air Pollutants Since 1990s’.47 If anything, Grossman and Krueger were too pessimistic about how long it would take for outcomes to improve.

As countries get wealthier, they can afford to reduce pollution.

In 1972, the Club of Rome predicted that the world would run out of oil by 2003 if oil consumption did not slow down, and by 1992 if consumption continued to grow.

Whoops.

As oil prices rose from the mid-1970s and consumers demanded more fuelefficient cars, substitutes for oil were found and previously uneconomical reserves became worth exploiting. Rising oil prices first encouraged innovation in the Alberta oil sands, then brought us massive amounts of cheap natural gas through hydraulic fracturing. And the rare earths crisis fizzled to nothing as the threat of increased prices both encouraged manufacturers to consider other alternatives and provided incentives for new rare earths mining outside China. If urbanisation ever turned any substantial amount of farmland into subdivisions, the consequent rise in the value of farmland and price of food would both encourage innovation in improving crop yields and in developing denser urban living environments.

The best signal of scarce resources is price. The worst signal is politicians claiming a resource is running out so we must stop using it.

And how to get more economic growth:

All else being equal, a government that makes up 35% of a country’s economic activity rather than 25% is associated with a 0.5 to 1-percentage point reduction in annual economic growth rates.

And over a couple of decades that difference in growth rates has a massive impact on incomes.

And Sweden is relatively open to free trade, which matters as the international literature suggests that a 1-percentage point increase in export growth is associated with a 0.2-percentage point increase in economic growth.

So we should support trade agreements that improve exports.

Income taxes are worse for economic growth than indirect taxes like GST. And while redistributive spending on transfer payments can be harmful for growth, investments in education can improve growth.

So cut income taxes, increase GST and spend more on education where it will do the most good.