Why governments need growth

My personal income is lower now than it was 20 years ago - in nominal as well as real terms. But I’m happier in my work and life now than I was then. Which poses the question: why do the main political parties regard the threat of stagnation with such fear? Why don’t they accept that they have no great ways to materially increase long-run growth - this generally witless collection of proposals highlights the paucity of thinking - and think instead about ways to improve Mill’s “art of living”?

The answer, I suspect, is that governments need economic growth, for a mix of reasons:

1. Economic growth is necessary, if not perhaps sufficient, to reduce unemployment.

2. To overcome Baumol’s cost disease. The relative cost of government services such as health and  education tends to rise over time; this is not (just) because of public sector inefficiency - look at how private school fees have risen - but because of the nature of the beast. Without economic growth, this tendency would generate a rising tax burden and growing tax resistance.

3. To get out of a debt trap. Higher growth allows governments to run looser fiscal stances whilst stabilizing the debt-GDP ratio. It’s an alternative to austerity or the embarrassment of monetizing the debt.

4. Economic growth can divert attention away from questions of equality and redistribution. If per capita GDP grows by 2.5% a year then in 25 years time we’ll be 85% better off. This means that, ceteris paribus, the minimum wage will be £450 a week - not far shy of the median wage today. The passage of time, then, relieves poverty. If, however, the economy stagnates then poverty relief becomes a zero-sum game; it requires actual redistribution.

5. In a normal growing economy, a government that promises economic growth can take the credit for what probably happens anyway, as a result of private sector decisions.

All of these reasons have something in common. They all suggest that economic growth is helpful in preserving the legitimacy of the state. Sustained mass unemployment can generate riots and crime or - remember the 30s - worse. The higher taxes that points 2, 3 and 4 suggest would accompany stagnation would lead others to suddenly discover their inner libertarian, and would intensify distributional conflicts. And the absence of growth would sharpen the question: what the heck is it that governments do for us anyway?

This is no idle pessimism. The decline of growth rates in the 1970s led to serious talk of a “crisis of democracy” (pdf). Who’s to rule out a repeat?

In this sense, I fear some greens under-estimate the trouble which and end of growth would cause.Maybe governments are right to fear stagnation. Which makes it all the more troubling that they can do so little to stop it.

Comments

[George Hallam]

"If per capita GDP grows by 2.5% a year then in 25 years time we’ll be 85% better off"

Just like it did in the US over the past 25 years?

[Gareth]

NGDP NGDP NGDP. Come on, Chris. You are conflating issues of nominal and real growth here, which is poor form.

You don't need real growth to get out of a "debt trap", you "just" need nominal income to grow. Hence why NGDP targeting is so blooming important, and the fact that most people don't understand the difference between real and nominal GDP is so depressing.

NGDP is everything.

[UnlearningEcon]

Gareth,

NGDP isn't everything. RGDP preserves its importance as a measure of increased production of goods and services.

Chris,

I think you have misunderstood Baumol's Disease (although there is a likelihood I have). It is a *result* of growth (or wage growth, anyway) - wage gains are generally evenly spread but productivity ones are not. Without growth it would not happen.

Also, point 4. ignores rivalry - people estimate their wealth relative to others, and so don't feel any richer - as well as positional goods.

[BT]

Nominal GDP growth is important for getting out of a balance sheet recession, or indeed any recession.

But real GDP growth is also essential to accommodate population growth. Plus accommodating any actual increase in the volume of goods and services thanks to innovations. Without any real GDP growth, a population boom would just lead to recession.

So a 100% sustainable economy with no population growth or technological change will still require nominal GDP growth to avoid recessions.

[chris]

@ Gareth - NGDP growth without RGDP growth is just inflation. This doesn't get us out of a debt trap, partly because a lot of our debt (about a quarter IIRC) is index-linked, but also because expected inflation would possibly raise gilt yields and hence nominal borrowing costs. To inflate the debt away, the inflation must be unexpected.
@ Unlearning - I'm not sure. You could get BCD with zero growth if wages match productivity gains in those sectors of the economy where productivity is growing, even if productivity isn't growing on average.

[BT]

@ Chris

Inflation does get the private sector out of a balance-sheet recession debt trap, which would then raise revenue for the government over and above the increased revenue caused by inflation itself (because unemployment would go down).

In a balance-sheet recession, inflation expectations are always going to be low, even if the government is its best trying to create inflation through borrowing and spending.

[Metatone]

It's kind of depressing to you subscribe to the managerialist belief that no action can be effective in creating, well anything... in this case growth.

That aside... part of the problem with this piece is that your income was high enough to start with that you could downshift and get happier. It's a lot harder to do that from a lesser starting point.

[Gareth]

Alright, NGDP is *nearly* everything. I blame Sumner and Rowe.

"partly because a lot of our debt (about a quarter IIRC) is index-linked, but also because expected inflation would possibly raise gilt yields and hence nominal borrowing costs"

Very, very poor form. What BT said. And... "Raise gilt yields?"... oh noes! Are the bond vigilantes taking over? Don't tell Krugman. We only need a few years of high NGDP growth, then back on the 5%-ish trend. Long gilt yields reflect expectations for long-term NGDP growth rates - we won't turn into Greece overnight.

If I was Chancellor I'd get the DMO to finance a year or so up front to lock in those yields, *then* flick the big red switch marked "NGDP BOOM".

[Keith]

I agree that Chris is very unrepresentative in terms of his income. Most people are not in this position as they did not go to Oxbridge and walk into a high pay city job while Thatcher cut taxes for the afore mentioned city types. Chris can choose to say good bye to most of his income as he did very well out of the Iron Lady. And the previous Social Democratic policies of Atlee, Bevan, Macmillan, Wilson, Heath and sunny jim callaghan.
Millions of other people did considerably less well and are going to do a lot less well very soon thanks to the Eton mess being brewed up by the Government of millonaires.

The issue is also complicated by public services. Cutting the NHS has a disproportionate effect on Human happiness
compared to cuts in the Income of well off city gents like Chris, not only does he need his marginal Income less than poor people but cutting and disorganising the NHS will produce more death and pain for those affected. At the margin at least some people will be drastically affected by spending austerity which includes some people who have high income. Public spending cuts impoverish the workers in the state sector and will harm potentially any one. So while you can dispute the importance of growth in personal income the affects on the public of changing the balance between public consumption and private Consumption are also relevant. If chris needs emergency medical teatment after an accident or terrorist bomb explosion he had better hope the austerity has not removed the capacity of the state to keep him alive. Rather than waiting for the bomb to go bang it is better to plan for adequate spending levels just in case.

One matter that is curious to me is why so many people seem to think real economic growth is suddenly impossible? Growth of 2.5 to 3 per cent in productivity Per year should be possible with progress in technology and has been achieved for longish periods mostly under social democratic policies. The Green party seem to me to have policies that are more likely to produce growth than the Coalition as the greens want Investment in infrastructure and housing rather than relying on Banker magic and supply side twaddle. So why Chris is hostile to the greens is a mystery. Moving away from fossil fuels for example is a good long term growth plan. If such fuel is going to become very scarce and so costly it is a bad idea to depend on it so much. When its price rockets from its limited supply growth will stall if our economy depends on it so much as it does now. The absurd joke of the atavistic tory MPs baying for cuts to fuel duty is worth pointing out. Lower tax on fuel will boost consumption if done on a big scale and where are they going to get more of the stuff? Like over fishing if you catch all the fish and they cannot breed you run out of fish to eat.

[guthrie]

Sparked by Keith's post, I ask you what does cause growth anyway?
Discovery and exploitation of new resources, eg oil? More efficient ways of doing old things, e.g. the incredible improvements in productive efficiencies over the last 200 years? Or indeed the computer revolution.
In which case, what is supposed to be involved in growth nowadays in the developed countries? What can grow in the UK?

[Matthew]

"expected inflation would possibly raise gilt yields and hence nominal borrowing costs"

I used to believe this but I'm becoming more sceptical. What if investors have nowhere else to go, ie all countries are doing it?

----

Chris your nominal and real income might have fallen but are you not consuming any of that past income - housing for example?

[chris]

@ Guthrie - most growth in developed economies comes from more efficient ways of doing old things, or from new products. This is why growth may have slowed; there are fewer significant new products, and because there are fewer new entrants into existing businesses, there's less productivity growth.
@ Matthew - I'm not consuming past income; I save half my current income. The only point of my experience is to show that a long-run decline in income need not be catastrophic, which only makes it odder that a small decline in national income is regarded with universal horror.

[Ralph Musgrave]

Re Chris’s No.1, economic growth is only necessary for unemployment reduction purposes ASSUMING CONSTANT OR RISING output per head (or rising “productivity”). But it wouldn’t take a genius to combine FALLING productivity (i.e. negative growth) with full employment.

Re No.3, growth is totally unnecessary for the purposes of “getting out of the debt trap”. Reducing national debts is ease: step 1, print money and buy back debt. Step 2, to the extent that “1” is too inflationary, counteract that with a deflationary method of getting money with which to repay debt: raise taxes (and or cut public spending). As long as the above inflationary effect equals the deflationary effect, GDP remains constant, while the debt declines. For more details, see:

http://mpra.ub.uni-muenchen.de/34295/1/MPRA_paper_34295.pdf

[George Carty]

Ralph, doesn't falling domestic productivity just mean though that you get outcompeted by more productive foreigners?

[Gareth]

"step 1, print money and buy back debt.
Step 2, to the extent that “1” is too inflationary, counteract that with a deflationary method of getting money with which to repay debt: raise taxes (and or cut public spending)"

Wow. That's brilliant, Ralph. If only we had thought of printing a bunch of money to buy back debt, and also raising taxes and/or cutting spending, all at the same time.

To do this, though, you'd really need a specific target for what is "too inflationary". And in fact, you really want to leave a tonne of gilts outstanding because the private sector needs a source of highly liquid risk-free assets.

So in fact, maybe you could try to buy back "just enough" bonds to create "enough inflation" without being "too inflationary". Maybe we could invent an organisation to do this called "the Bank of England". Shall we call the process "quantitative easing"?

[matthew.turner@gmail.com]

But your net assets must be vastly higher than they were? In general i think rich people underestimate the importance of savings/assets.