Tuesday, August 30, 2011

The growth dogma

As we all know, the rich world has a debt problem. It's been living beyond its means for some time now, a situation exposed in so many ways by the 2008 financial crisis. Governmment finances in particular are in disarray, as they have been forced to bail out their banks, are receiving less in tax and paying more in benefits. Without drastic action, government blance sheets can only deteriorate further as demographic change (primarily aging populations).

The obvious solution is to- cut Government spending, as some countries have done. Economists and capital markets, however, fret that spending cuts are contractionary and will increase debt-to-GDP ratios by shrinking economies. In general, they are looking for short-term measures to boost growth, arguing that a larger economy is better able to support its debt.
Prima facie, the economists are right. This view encompasses some dangerous thinking, however.
Firstly, it rests on the idea that economies can continue to grow indefinitely, and that there is no limit to the size of a country's GDP. That's a fallacy. The Earth has limited resources (some of which are in the process of being exhausted) and that necessarily puts a cap on average living standards. It is ultimately a zero sum game (at least in respect of primary and secondary output).
Secondly, countries are running into productivity limits. If your enterprises already employ the best and most efficient practices, then there is no way you can make your labour and capital inputs more productive. This is the situation many western economies find themselves in and explains why developing economies tend to grow faster than developed ones.
Thirdly, the targeting of GDP growth by governments is undemocratic. The 'rewards of growth may go to only a small section of the population. The current recovery, for example, is mainly focused on growth in corporate profits; unemployment levels grew rapidly during the recession, and now seem stuck at permanently higher levels. The GDP measure is not directly concerned with the aspirations of the people to have a well-paid & interesting job, access to quality education & healthcare etc. These aspirations are what governments should be focussing on and measuring themselves against.
Fourthly, the targeting of growth can lead to some poor policy decisions. Possibly the prime example of this was the debt-fuelled phoney growth of the recent past. So long as governments can borrow and central banks can print money, the generation of phoney, short-term growth remains an option, even if it exacerbates balance sheet weakness or undermines the currency.
The answer I think, is for Governments to measure themselves against targets that really matter to voters. The UN's human development index (HDI), though far from perfect, may be the best current example of a single- figure measure that could be adopted. As well as pure economic elements, it includes items such as the literacy rate, numbers of doctors per capita, respect for human rights etc.
It may be best to consider GDP not so much as a measure of an economy's success, but rather (in part at least) as a measure of a country's annual call on the earth's resources. The goal of good government would then be the maximisation of its HDI subject to the constraint of maintaining or even reducing GDP.
It can be done, but it will require policy prescriptions very different from those designed to produce short-term reflation. I have some idea what those policy prescriptions should look like, but I think I'll address those in another post. It suffices to say that moving away from GDP targeting will welp the West move away from an economic model based on importing and consuming and towards one based on things of more fundamental importance. This, in turn, will allow the mountains of debt, both public and private, to begin to be reduced.

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