Misunderestimating Growth

The Economist's Free Exchange blog examines why the transformative power of economic growth is so little appreciated.

The now-well-documented historical record suggests that economic growth has done more for the welfare of humanity than any moral creed or non-economic initiative meant to improve the dignity and quality of human life. So why is there no treatise required of all undergraduates singing growth's praises and setting it out as a moral imperative for all decent peoples?

The post discusses several explanations: (i) people do not understand compounding growth, (ii) historically speaking, sustained growth is a relatively new phenomenon, and much of our religion and philosophy predates it and (iii) we find it easier to imagine future disasters than the positive effects of growth.

An illustration of the power of growth from principles class is that Japan and Mexico both had real per capita GDP of just over $1,000 (in 1990$) in 1890. Over the next 110 years, Mexico's per capita GDP increased sevenfold (!) to $7,249, and Japan's increased twenty-one times (!!) to $21,051. Mexico's average annual growth rate over the period was 1.8%, and Japan's was 2.8% - only 1% higher, but over 110 years that is the difference between being a "rich" and a "middle income" country. [data are from the best spreadsheet ever, Angus Maddison's Historical Statistics for the World Economy: 1-2003 AD]

One person who understood compound growth was John Maynard Keynes. In his famous essay "Economic Possibilities for our Grandchildren," he foresaw growth solving the "economic problem" of scarcity and making possible dramatic social changes and liberation from social values oriented towards capital accumulation:

When the accumula­tion of wealth is no longer of high social im­portance, there will be great changes in the code of morals. We shall be able to rid our­selves of many of the pseudo‑moral principles which have hag‑ridden us for two hundred years, by which we have exalted some of the most distasteful of human qualities into the position of the highest virtues. We shall be able to afford to dare to assess the money‑motive at its true value. The love of money as a possession ‑ as distinguished from the love of money as a means to the enjoyments and realities of life ‑ will be recognised for what it is, a some­what disgusting morbidity, one of those semi­criminal, semi‑pathological propensities which one hands over with a shudder to the specialists in mental disease.

With scarcity behind us,

for the first time since his creation man will be faced with his real, his permanent prob­lem ‑ how to use his freedom from pressing economic cares, how to occupy the leisure, which science and compound interest will have won for him, to live wisely and agreeably and well.

Although Keynes understood the power of growth, it seems he underestimated our ability to create new material wants, and perhaps overestimated how quickly our value systems could change.

As for why we still fail to appreciate economic growth, I would add a fourth reason: we don't really know how to improve it. Although there is quite a bit of fascinating research being done, the improvements of "total factor productivity" that are the main driving force of growth remain elusive. Moses Abramovitz once described the Solow residual (which is how total factor productivity is measured), as a "measure of our ignorance." That still holds some truth today.