Friday, 4 April 2014

Waiting for Economic Growth Is Wishful Thinking

I constantly come across reports claiming economic growth in Europe and the US is picking up. Many draw this conclusion from looking at changes in GDP. An increase in GDP is an increase in economic growth the thinking goes. But true economic growth is defined as "an increase in living standards". Without getting into a long debate of whether GDP growth is an indicator of economic growth, it perhaps suffices to ask whether U.S. citizens today really are 16.3% better off than they were at the end of 2007. This happens to be the overall growth in GDP from Q4 2007 to Q4 2013? 

A higher living standard means we are able to satisfy more of our wants. To achieve this we need to save and invest in order to produce goods and services to satisfy this end. The more efficient we become at these tasks, the more we produce and the more we can ultimately satisfy these wants through the act of consumption. By producing and consuming more of what we want and allocating resources in the direction of producing the most urgent wants first (and then proceeding down the wish list), we become better off economically speaking.

It's the role of businesses to produce goods and services that satisfy consumers wants and needs. For these business to operate and to become better at what they do, they require savings which can be channeled into investments and producers goods which leads to the building up of capital. Capital accumulation means that business can produce not only more consumer goods than before, but also produce those goods more efficiently. This leads to not only cheaper goods and services ceteris paribus, but also higher wages as workers become more productive as a result. Taxes reduces the amount of savings in an economy and hence the resources available for investments.

The market is an intricate web of actors and prices that interact on a continuous basis to exchange those goods and services produced. It consists of people who exchange something they want less off (selling) for something they want more (buying). Everybody choosing to exchange based on their free will wins (at least ex ante). This market is made up of all of us, both producers and consumers, independent of religion or political beliefs and includes actors which are short and tall, nice and mean, black and white and rich and poor. The market is an integral part of civilized society, without it there would be no society as we know it. It's the most wide spread form of social co-operation that exist. Strangely, this is too often forgotten about by politicians, voters and even some economists. Worse yet, some are not even aware of this fact.

For businesses to produce and for the market to work as efficiently as possible, both require minimum government intervention, which only serves to substitutes coercion for voluntary actions and to distort all important price signals.

To summarise, for economic growth to take place the following are prerequisites:
  • An increasing proportion of people need to take part in the actual production of goods and services
  • Increased savings to fuel investments and capital accumulation
  • A reduction in government interventions

We here come to the crux of the matter: for economic growth to take place, governments must shrink in size and a larger proportion of people need to work in the productive sector. The overall tax burden must be reduced to allow an increase in savings. In addition, government intervention in the market needs to end and unnecessary regulations of the market must be removed. If not, nothing will fundamentally change as these factors combined explain much of the reason both Europe and the US entered the recession in the first place. 

Finally, all that went wrong in both the U.S. and Europe was made possible through fractional reserve banking systems supported by central banks. Such a system makes it possible to create money out of thin air which can then be used to finance a range of projects that otherwise would not have been able to attain finance. The monetary system hence also need to be improved to make it impossible for undue expansion of the money supply (see here for more on this).

To raise the prospects for achieving economic growth going forward, we need to change what was wrong with the economy in the first place. Otherwise, expecting and waiting for economic growth would be wishful thinking at best. Above I have tried to highlight some of the key areas that are holding economic growth back. Of course, businesses become better every day at producing even with high taxes and intervention*. This by itself creates some growth, but the growth would be modest at best and significantly below what it could be.

*And we could of course suddenly discover a giant deposit of oil reducing the price accordingly.