Wednesday, November 26, 2014

Rethinking the Growth Imperative

CAMBRIDGE – Modern macroeconomics often seems to treat rapid and stable economic growth as the be-all and end-all of policy. That message is echoed in political debates, central-bank boardrooms, and front-page headlines. But does it really make sense to take growth as the main social objective in perpetuity, as economics textbooks implicitly assume?

Certainly, many critiques of standard economic statistics have argued for broader measures of national welfare, such as life expectancy at birth, literacy, etc. Such appraisals include the United Nations Human Development Report, and, more recently, the French-sponsored Commission on the Measurement of Economic Performance and Social Progress, led by the economists Joseph Stiglitz, Amartya Sen, and Jean-Paul Fitoussi.

But there might be a problem even deeper than statistical narrowness: the failure of modern growth theory to emphasize adequately that people are fundamentally social creatures. They evaluate their welfare based on what they see around them, not just on some absolute standard.

The economist Richard Easterlin famously observed that surveys of “happiness” show surprisingly little evolution in the decades after World War II, despite significant trend income growth. Needless to say, Easterlin’s result seems less plausible for very poor countries, where rapidly rising incomes often allow societies to enjoy large life improvements, which presumably strongly correlate with any reasonable measure of overall well-being.

In advanced economies, however, benchmarking behavior is almost surely an important factor in how people assess their own well-being. If so, generalized income growth might well raise such assessments at a much slower pace than one might expect from looking at how a rise in an individual’s income relative to others affects her welfare. And, on a related note, benchmarking behavior may well imply a different calculus of the tradeoffs between growth and other economic challenges, such as environmental degradation, than conventional growth models suggest.

To be fair, a small but significant literature recognizes that individuals draw heavily on historical or social benchmarks in their economic choices and thinking. Unfortunately, these models tend to be difficult to manipulate, estimate, or interpret. As a result, they tend to be employed mainly in very specialized contexts, such as efforts to explain the so-called “equity premium puzzle” (the empirical observation that over long periods, equities yield a higher return than bonds).

There is a certain absurdity to the obsession with maximizing long-term average income growth in perpetuity, to the neglect of other risks and considerations. Consider a simple thought experiment. Imagine that per capita national income (or some broader measure of welfare) is set to rise by 1% per year over the next couple of centuries. This is roughly the trend per capita growth rate in the advanced world in recent years. With annual income growth of 1%, a generation born 70 years from now will enjoy roughly double today’s average income. Over two centuries, income will grow eight-fold.

Now suppose that we lived in a much faster-growing economy, with per capita income rising at 2% annually. In that case, per capita income would double after only 35 years, and an eight-fold increase would take only a century.

Finally, ask yourself how much you really care if it takes 100, 200, or even 1,000 years for welfare to increase eight-fold. Wouldn’t it make more sense to worry about the long-term sustainability and durability of global growth? Wouldn’t it make more sense to worry whether conflict or global warming might produce a catastrophe that derails society for centuries or more?

Even if one thinks narrowly about one’s own descendants, presumably one hopes that they will be thriving in, and making a positive contribution to, their future society. Assuming that they are significantly better off than one’s own generation, how important is their absolute level of income?

Perhaps a deeper rationale underlying the growth imperative in many countries stems from concerns about national prestige and national security. In his influential 1989 book The Rise and Fall of the Great Powers, the historian Paul Kennedy concluded that, over the long run, a country’s wealth and productive power, relative to that of its contemporaries, is the essential determinant of its global status.

Kennedy focused particularly on military power, but, in today’s world, successful economies enjoy status along many dimensions, and policymakers everywhere are legitimately concerned about national economic ranking. An economic race for global power is certainly an understandable rationale for focusing on long-term growth, but if such competition is really a central justification for this focus, then we need to re-examine standard macroeconomic models, which ignore this issue entirely.

Of course, in the real world, countries rightly consider long-term growth to be integral to their national security and global status. Highly indebted countries, a group that nowadays includes most of the advanced economies, need growth to help them to dig themselves out. But, as a long-term proposition, the case for focusing on trend growth is not as encompassing as many policymakers and economic theorists would have one believe.

In a period of great economic uncertainty, it may seem inappropriate to question the growth imperative. But, then again, perhaps a crisis is exactly the occasion to rethink the longer-term goals of global economic policy.

Read more from our "Imperfect Indicators?" Focal Point.

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    1. CommentedThomas Cheney

      Why can't we have a steady state economy? We might need a modified banking system, but nothing seems wrong with the economics of sufficiency and wellbeing over conspicious consumption.

    2. CommentedNicolas Bollion

      I agree that economic growth shouldn't be a goal in itself. But is this really the case today? At least in my country, working time has dropped steadily over the past decades and leave has been expanded. We've seen a huge proliferation of environmental rules, which probably have slowed down growth at a certain moment.

      Indeed, happiness hasn't increased much since WW2 although GDP/capita has grown significantly. But maybe we should ask what would have happened to our well being if our economy had stalled since. Maybe we needed some growth to keep well being stable. Women have entered the labour force and, a result of emancipation. This was not intended to make economy grow. There is the innate propensity of man to discover new things, to do things better and to search for challenge. I think this is the real dynamic behind long term growth and not materialism. We can not collectively forget past discoveries.

      Of course there are some drawbacks connected to growth like environmental problems. Yet, in advanced countries pollution has decreased in spite of growth (and even continuing industrial output growth), wheras future growth will probably come from service sector.

    3. Commentedphilip meguire

      Take two nations with comparable GDPs per capita and educational attainment. The residents each nation have some opportunities to visit the other. One nation grows at an average of 2% p.a. for 50-100 years. The other grows at 1.5% p.a. After 150 years, the real GDP per capita of the faster growing nation will be twice that of the slower growing nation. The difference in lifestyles will be blatant to the most casual observer, and residents of the slower growing nation will feel hopelessly inferior.

      Restrictions on the ability of the Soviets and Chinese to travel abroad delayed this outcome, but could not prevent it. The scenario I have described also applies literally to Australia and New Zealand. In 1960, those nations had very similar standards of living. Today, Australia is 25-30% ahead of New Zealand. Sydney and Melbourne are far more sophisticated than Auckland.

      Once a non oil exporting nation reaches a GDP/head of about US$35-40K, growth at a rate faster than 2% p.a. is elusive. That is an implication of the neoclassical growth model. But for an OECD nation to retard growth deliberately, is not an option either.

    4. Commentedphilip meguire

      Dear Mr Durante:
      The idyllic utopia you describe was tried -- in the USSR and to a lesser extent in China. For 60 and 30 years, respectively. You know the outcomes. The one deviation from your utopia is that work was compulsory, at wages set by the Powers that Be. For many millions, that wage was the meagerest of food, plus one set of summer and winter clothes of the shabbiest cut.

      Dear Mr Shedd:
      It is probably true that given current technology, the typical OECD lifestyle cannot be extended to the entire human race. Any attempt to do so will meet with disaster well before the change is complete. Many see this as a reason to dismiss our lifestyles. I prefer to see it as a challenge for human ingenuity. But one thing is certain: Mr Durante's suggestion is not a path forward.

      Dear All:
      I agree that over the next 100 years, the growth rate of the human population should fall below 0.2% p.a., and I would accept a value of 0. I also embrace nuclear, solar, and geothermal energy. I even advocate a minimum guaranteed income of $100/person/week, free of tax. Most important, we are going to have to learn to derive more satisfaction from creativity and human fellowship, and less from the purchase of items that wear out and go out of fashion. But the public sector is not an appropriate means to meeting these existential challenges.

    5. Commentedjames durante

      Interesting that this article, which questions one aspect of capitalist ideology (religion) had received only 1 comment.

      Gross National Happiness. Imagine a subsistence economy where subsistence is defined in realistic, modern terms. A small house with enough solar power for stove, fridge, and electric car; enough basic foodstuffs and variety to allow for good health; and a small variety of quality clothes. This is guaranteed to all in exchange for 20 hours of work per week to provide exactly these items. (I can't imagine that robotics and other high tech couldn't cut this necessary work time to less than 20.) The food-energy-transport-housing-clothing sectors could involve regulated monopolies. Any land/resources needed to provide more than this would be subject to strict public scrutiny and any labor would have to be purchased at a premium as no one is forced to work. Their basic needs are met. After all, it is the NECESSITY of selling labor power that drives wages down and profits up.

      Gross National Happpiness.

    6. CommentedGordon Shedd

      Professor Rogoff, please continue to question accepted "wisdom" that is, in actuality, only unexamined dogma. It will probably take a century to change the general perception of growth, and it will only happen in one of two ways: 1. after extended efforts by generations of economists and commentators like yourself, or 2. after the world's resources are almost completely depleted, and the end of the road is apparent. The former alternative is preferable, but, as we've seen in the case of global warming, selling the idea of an impending disaster that cannot be proven until it has occurred is an uphill struggle. If we let consumption-based economic growth continue unabated until there are 8 billion humans consuming like the developed world does now (which is, ultimately, the goal), then it will be too late for a happy ending.