The Diseconomics of Growth

H.V. Hodson

Chapter II.

The Concept of Economic Growth

To understand how much of the popular cult of growth is myth we must go back to its theological origins. We do not have to go back very far. The biblical texts of this religion have an old testament and a new testament. The old testament is classical economics from Adam Smith to Alfred Marshall: its minor prophets still abound. One new testament which we of the liberal-capitalist world regard as heresy began with Marx and Engels. The Communist economic doctrine was stern and denunciatory; it offered salvation only to the elect, and only through the baptism of revolution; but it did believe in salvation. Our liberal-capitalist new testament began much later, has no Messiah, and is even now far from canonically received.

Among the nineteenth-century economic philosophers Karl Marx did create a dynamic theory of national economy. It may have been falsely grounded, over-materialistic, over-dogmatic, wrong in its predictions of the fragility of capitalism, but it was concerned with economic change, advance and decline, and it provided a formal apparatus capable of developing an analysis of economic growth and its effects. This merit, besides its apocalyptic and revolutionary appeal, has been an important reason for the long and still continued life of Marxism as a base for academic economic philosophy. In hard practical terms, too, the Stalinist aim of overtaking capitalism in production impelled Soviet economists to closer study of how a total national economy might expand, and expand rapidly, than was practised in the laissez-faire Western world, where economic expansion was expected to happen in the system’s due time. The conceptual study of economic growth by economists in the Western tradition is quite remarkably recent. Of course, from Adam Smith onwards economists have been interested in the total “wealth of nations” and changes in it, as well as in how it is created and how it is divided between different classes or “factors of production.” According to Walt Rostow, The Wealth of Nations (1776) “is a dynamic analysis and programme of policy for an under-developed country. Adam Smith was concerned to see created a social and political framework appropriate to a policy of sustained economic growth in Britain and the world.” But anyone who looked to him for a theoretical analysis of growth would be disappointed. The title of Book III, “Of the different Progress of Opulence in different Nations,” excites such hopes in vain. For its chief conclusion is that the progress from foreign commerce to “the finer manufactures,” and thence to “the principal improvements of agriculture”—which Adam Smith observes had happened in “all the modern states of Europe,” and which we recognise as one characteristic path of economic growth today—is an “unnatural and retrograde order of things.”

Marshall, likewise, more than a century later, while elaborately discussing in his Principles of Economics (1890) the factors governing the rate of growth and productivity, failed to offer any formal analysis of long-term growth. His successors in the classical school made but slow advance in this respect. They treated the economy rather as a machine ticking over well or ill, faster or more slowly, than as an organism constantly in motion and growing as it moved. Classical economic analysis was more like mechanical statics than dynamics (or hydrodynamics, which is really the better analogy for so fluid a system).

The breakthrough came, significantly, not on the main track—that is to say, analysis of how long-term changes in a nation’s total economic product were generated, how they could be measured, why they might vary from time to time or place to place and how they were affected by public policy—but on a side-line, namely, the study of the so-called “business cycle” of boom and depression. This subject had preoccupied many eminent economists for two generations. The clue to advance was found in the work of Maynard Keynes. It is hard to recapture today the sense of new light which broke upon the younger economists, trained in the classical school, when Keynes’s General Theory of Employment, Interest and Money was published in 1936. Paul Samuelson, now a Nobel prize-winner for economics, even invoked, many years afterwards, Wordsworth’s famous lines on the French Revolution:

Bliss was it in that dawn to be alive,
And to be young was very heaven.

But this was obituary exaggeration. Keynes’s contemporaries saw no revolution, only a sophisticated development of business-cycle analysis.

The secret of Keynes’s immense influence on later economic thought and action, in fact, lay not in any dramatic theoretical discovery but in the fact that—as his colleague Professor Austin Robinson has written—

Keynes was always an applied economist, a political economist. When he tackled problems of economic theory, it was not from joy in trying to solve different intellectual problems. It was because the immediate painful and practical problems of trying to make the world economically a better place required first the improvement of the economist’s techniques of thinking about them.

His General Theory, composed when Britain had two million men and women out of work, focused upon the problem of unemployment and full employment. It is concerned with stability and equilibrium rather than with growth, those being the crying needs of the economic world of the 1930s; and the concept of growth finds no distinct place in it. Professor Schumpeter of Harvard, besides dubbing the work “a piece of depression economics,” complained indeed that it was not dynamic. Even Keynes’s friend, admirer and eventual biographer, Roy Harrod of Oxford, wrote:

The only criticism of Keynes which I venture to offer is that his system is still static. The distinguishing feature of the dynamic theory will not be that it takes anticipations into account, for these may affect the static equilibrium also, but that it will embody new terms in its fundamental equations, rate of growth, acceleration, deceleration, etc.

Note the characterisation of “rate of growth” as a “new term”. “Dynamic theory” was still referred to in the future tense. That was in 1937, when many of today’s eminent professors of economics were already teaching.

Nevertheless, it was from the Keynesian system that Western economists’ subsequent study of growth sprang. To quote Professor AC Pigou of Cambridge: “When a man has devised a new way of tackling an unclimbed mountain, we may, indeed, regret that this way has not led him to the top. But for the effort which has advanced him towards the top nothing is due but praise.” Keynes’s innovations were his emphasis on expectations in the decisions of consumers, investors and other partners in the economic process, and his analysis of the critical effect of the savings-investment balance. He thereby unclasped the dead hand of an ancient economic axiom called (after an eighteenth-century French sage) Say’s Law, which affirmed, in effect, that total supply and total demand were always equal, since every cost of production was also someone’s purchasing power. It is easy to see how this doctrine baulked the development of dynamic theory. Keynes’s analysis rescued economic theory from Say’s Law and opened the way to a conceptual analysis of growth.

Even the economists who embarked upon it, however, were remarkably coy about using the term “growth” itself. If you look down the titles of books on this aspect of economics, before the 1950s it seems that almost every synonym was used—Expansion, Development, Progress, Change, Disturbance, Dynamic—as if “growth” were a vulgar four-letter word, to be disguised on a title-page by some many-syllabled substitute. Only around the year 1950 (for instance in Walter Rostow’s creative work, The Process of Economic Growth) does Growth itself appear as an accepted, familiar catch-term, fit for a book-title. “There is a ferment in the world of economics,” Rostow observed: “from different initial interests, academic theorists in many parts of the world are beginning to pose a new set of questions addressed, roughly, to the process of economic growth, and the character of its relation to short-period income analysis.”

Why 1950? There is, of course, a time-lag in the progress of economic as of any scientific thought and terminology, and it may be that the younger generation of economists who took off from Keynes’s General Theory were reaching maturity a dozen years later, after the interruption of the war. But we can perceive other, more significant reasons. Economists who sought dynamic theories between the two World Wars had been preoccupied with the ways in which national economies got into ruts of depression and unemployment and might climb out of them. They were less concerned with the long-term curve than with the dips and bumps in it, less with overall economic management than with monetary policy, less with growth than with equilibrium. After 1945 the scene had changed.

In all the liberal-economy nations that fought in World War II, governments had been obliged to take on many functions of direction and control over the economic system. Their peoples became accustomed to the idea that it was the business of national management to see that the economy as a whole prospered and that everyone benefited from its prosperity. The countries that had been devastated faced problems of reviving production from low levels, of fostering growth from a cut and withered stem. More fortunate countries were able to give priority in national economic management, to socio-economic goals which had been made politically vital by wartime social changes and reaction from pre-war discontents: fair distribution of National Income, full employment, “welfare” insurance and support for the economically weak or disabled. The British government wrote into its pledged objectives the maintenance of a “high and stable level of employment;” and the Employment Act of 1946 in the United States charged the federal government, in co-operation with other sectors of the economy and in ways that would promote free competitive enterprise, with using “all its plans, functions and resources to promote maximum employment, production and purchasing power.” (The difference in emphasis is significant, and is to some extent reflected in the contrasted American and British views of what constitutes full employment: in the United States it has meant about 4 per cent unemployed, in Britain less than 2 per cent.) All this socio-economic commitment required knowledge of the National Product and of how it could enlarge itself or be enlarged to cover all these needs, which had not been deemed requisite in more laissez-faire days.

Furthermore, the tools were at hand. Wartime controls and government direction had given rise to a mounting flood of statistical information. Welfare and full-employment policies required more statistics, and evolved their own. New international bodies like the World Health and Food-and-Agriculture Organisations, or QEEC, did the same. The resultant phenomenon has been called by the Royal Statistical Society “the post-war statistical explosion.” It is a law of social science that theories will always multiply to match the statistics available (and so will statisticians).

All told, we need not wonder that as soon as the post-war reconstruction period began to end there should develop among economists a new science and philosophy of growth, linked with welfare. For fifteen years or more since then, studies of economic growth have proliferated. It cannot be said that they have shed clear light for the man in the street or the politician who has to take practical decisions. Economists are as much at sixes and sevens about the theory of economic growth as they ever were about classical monetary theory. There is the school of demand-led growth, the school of export-led growth, the school of investment-led growth, the neo-Keynesians, the post-Keynesians, exponents of rival doctrines among which the heresies have not yet been sorted from the orthodoxies. No wonder that, to the layman, economists nowadays seem to be talking to each other rather than to the rest of the world, like ecclesiastics who prefer theological refinement to pastoral counsel. One of the most balanced and practical of economists, Sir Alec Cairncross, wrote this in his concluding reflections on a Ditchley conference of leading British and American economists held to discuss the performance of the British economy (Britain’s Economic Prospects Reconsidered, 1971):—

We do not know for sure how the economy works, and it certainly does not work in the same way for long. The long-run relationships that should form the basis of growth policy seem to rest on social and political values at least as heavily as on economic variables. There is, moreover, no agreed theory of growth composing those relationships and providing the agenda for action aimed at accelerating growth... Few industrial countries would claim that they know the recipe and could devise policies to add one or two percentage points to their rate of growth.

The economists’ arguments have been concerned not only with the concept and mechanism of economic growth, but also with its motive impulse. If expanding demand were the cause of growth, what caused expanding demand—the buyer’s need or the seller’s offer? Answers to such questions affect the link between growth and welfare; for, if growth is held to originate with the inducement of wants not previously felt, there is no assurance that it raises real welfare. J. Kenneth Galbraith observed in The Affluent Society (1958):—

As a society becomes increasingly affluent, wants are increasingly created by the process by which they are satisfied. This may operate passively. Increases in consumption, the counterpart of increases in production, act by suggestion or emulation to create wants. Or producers may proceed actively to create wants through advertising and salesmanship. Wants thus come to depend on output... It can no longer be assumed that welfare is greater at an all-round higher level of production than at a lower one. It may be the same.

Professor Harry Johnson, of Chicago and London, in his Money, Trade and Economic Growth (1962), after quoting Marshall’s Principles of Economics on “the development of new activities giving rise to new wants, rather than of new wants giving rise to new activities,” made this trenchant comment:

The fact that wants are created, and not original with the individual, raises a fundamental philosophical problem, whether the satisfaction of wants created by those who satisfy them can be regarded as a social gain.

Thus growth theory had a number of conceptual dilemmas to face before it took the mechanistic form in which it is familiar to the public nowadays. Growth for the economic theorists of the 1950s was not a plain measurable fact, as it has now become in common parlance. Today, if you ask what is the economic growth-rate of, say, Italy, you will be answered with a precise figure, without theoretical preliminaries or laborious definitions. For the originating theorists, growth was a difficult and complex concept, which had to be carefully defined and analysed before it could be measured.

The economy of any country is a very elaborate thing, swelling here, shrinking there, changing altogether somewhere else. How to combine all these movements into a single formula? How then to measure it? There were some who followed the track of the productivity of labour, arguing that, since labour entered into everything, the rate of overall expansion must conform to changes in average output per man or per man-hour. But the limitations of this approach soon became obvious. The output of a great deal of labour—teaching, for instance—cannot be measured, at least in simple money terms: moreover, the fraction of total national economic effort involving that sort of labour government, education, health care, leisure services and so on—tends to rise. Even in manufacturing industry, technological changes make it impossible in many cases to compare labour-productivity from year to year, even the productivity of the same workers in the same factory making much the same product. Productivity, as every job-rate-fixer or wage negotiator knows, is very much something to be argued about.

Others sought an index of overall economic growth in changes in the nation’s capital stock, contending likewise that capital (including tools) was needed for the production of anything in a modern economy, and that a growth of capital therefore signalled a growth in output. Again the flaws showed up. By this method, a switch from capital-intensive activity, like heavy industry, to more labour-intensive activity, like public services, would indicate a negative growth which had not in fact occurred.

The solution found was to fall back on the established notion of national income. This was safe ground for economists, whose whole science is by definition limited to those things, processes and activities which can be expressed in money. Although Marshall and his successors had debated the subject, comprehensive statistical studies of national income got under way only in the 1930s—another strangely late date. Here is a typical quotation, from one of the pioneers, Colin Clark (National Income and Outlay, 1937), following the classical footsteps of AL Bowley and Josiah Stamp:

The national dividend may be defined for any period as those goods and services which flow into being during that period which are customarily exchanged for money, avoiding, of course, double reckoning... Net income corresponds to the above definition subject to a deduction equal to the cost of repairing and (in the course of years) replacing all the capital instruments used up in the production of the dividend: gross income is before the provision of such allowances... These allowances must be to a considerable extent a matter of conjecture. For this reason gross income is a more precise concept than net income, and for certain purposes at any rate is equally useful.

The usual basis of economic growth calculations today is in fact not net income but gross income, or Gross National Product. It does not allow, therefore, for repair and replacement.

For years the economists and statisticians argued about what should be included in national income, how different contributions to it could be measured, how to treat such items as imports and exports, capital investment abroad, private domestic work, “uneconomic” activities like defence expenditure. But the arguments had to be cut short because politicians, civil servants, public commentators demanded a definite answer, plain figures which they could use and publish as the properly certified national income. Though there are still fringe debates, most economists follow in practice established rules in computing national income, or Gross National Product. It does not really matter very much what the precise rules of the game are, so long as everyone observes them.

One unfortunately cannot guarantee that, even if the rules of computation are uniform, the material computed is equal. The figures used for the building-up of national income statistics vary greatly in reliability, and in the nature of their statistical basis, from country to country. International comparisons are consequently much more shaky than comparisons over short time-periods within one country.

The upshot of all this is that a product having the semblance of great simplicity and concreteness, in the shape of figures of national income and economic growth, has been distilled out of a brew of ideas and definitions which economists themselves would admit are still complex and uncertain. National Income figures are just what they inherently are, neither more nor less: an arithmetical sum of the money values of “those goods and services which are customarily exchanged for money.” Whether this agrees with what intuitively we might feel was the real national income, or what we might ideally define it to be, is very much open to doubt. Still more open is the question whether upward changes in that sum accord with what we might either personally regard or scientifically define as economic growth.

It will also be observed that, although growth economics had its origins in the economics of the business cycle, and although obviously the curve of economic growth, measured short-term, will probably have waves corresponding to those of booms and recessions, the measurement of growth is conceived and structured in a different way from that of business activity, and the two curves will by no means coincide. Still less growth can be identified with the movement of particular indices of business activity, for instance consumption of basic raw materials, or the numbers of vacant jobs. There is no necessary coincidence of growth and employment. Growth can go on while unemployment goes up. Long-term growth can stop while business temporarily booms.

At first sight, a state of continued growth must favour full employment, since a bigger output presumably means more jobs; but there are less superficial reasons for an opposite connection between the two. Growth of production does not happen, as a rule, without innovation and enlarged capital equipment, though of course it can do so, for instance through heightened efficiency of management. Such improvements in the technique or equipment, or indeed managerial efficiency, of industry, agriculture and commerce are apt to be labour-saving: in other words, they usually mean bigger output with fewer jobs. Often, too, growth depends on accelerated movement from older, less efficient industries or businesses to the more modem and efficient; such displacement itself is apt to cause so-called technological or transitional unemployment. To the extent that these facts hold good, there may have to be a choice between growth and “full employment.” Yet over and over again, in popular political and economic argument, in speeches and newspaper articles, especially in Britain since unemployment started rising from 1969 onwards, while growth was small or nonexistent, policies to “stimulate growth” are demanded as a means to solving the employment problem. Maybe, on the contrary, with less growth there could be more employment, for instance through a switch of national resources from advancement of industry to creation of jobs. Growth is no panacea for the familiar ills of the economic body, like unemployment or business fluctuations.

Fuller use of existing resources, both capital and labour, when these are partly idle through recession, will obviously increase the level of production and thus of national income. But the effect is transitory, and gives no assurance of economic growth in a longer perspective, any more than running an automobile at its optimum speed or with its tyres inflated to the best pressure makes it a larger or more powerful car. It is a once-for-all restoration of full activity to existing resources: their potential is unaltered. Which does more for economic growth, a one-time absorption of 2 per cent unemployed, or a 2 per cent annual rise in efficiency and output? The answer is obvious. Thus if the object is growth it is not necessarily best obtained by pushing up employment; nor is “full employment” necessarily obtained by going for growth.

Not all economists would agree with this reasoning. Professor Kaldor, for instance, in his Essays on Economic Stability and Growth (1960), concludes that:—

A state of Keynesian under-employment equilibrium, whilst it is perfectly consistent with a static short-period equilibrium, is therefore inconsistent (except by a fluke) with a dynamic equilibrium of steady growth.

But this conclusion is really implicit in the assumptions, or definitions of terms, from which Professor Kaldor works. He claims that:—

The assumption that there can be no under-employment equilibrium in periods in which the rate of growth of capital and income is normal is not arbitrary: it is based on the view that an equilibrium of steady growth is inconsistent with under-employment equilibrium.

This view, however, is itself based on the assumption, explicitly made by Kaldor for his model of economic growth, “that in a growing economy the general level of output at any one time is limited by available resources, and not by effective demand.” These assumptions, or definitions, can certainly be challenged. In a condition of continuing under-employment, production is not limited only by effective demand; in a condition of continuing full employment, production is not limited only by available resources. It may be partly limited in the first case by available resources (including labour) in particular places or industries. In either case it may be limited by defects of management, lack of enterprise, non-economic hopes and fears, marketing miscalculations, wear and tear of equipment, labour inefficiency, labour immobility, productive time lost. Progressive improvement in any or all of these respects, which could hardly be called a fluke, can lead to real and steady growth without improving the overall state of employment or unemployment.

We need to disentangle the concept of growth from its roots in the study of booms and slumps, above all the Great Depression of the 1930s. Unfortunately, the confusion between economic growth and business recovery persists unabated, as almost every political utterance or leading article on the subject shows. And this confusion breeds a further error. Many economists following Keynes (but not Keynes himself) believed that the formula for first reviving the economy and then maintaining it at a high level of activity must include a certain amount of inflation; that is to say, a certain excess supply of money and credit which would stimulate investment and, through well-founded expectation of a rise in price-levels, encourage business optimism. Supposing that to be true of recovering from business recession, it does not follow that inflation is a means to long-term growth. Practical examples indicate that they are disconnected. Galbraith, while rightly attacking the mischievous tolerance of inflation, is wrong in saying that “inflation—persistently rising prices—is obviously a phenomenon of comparatively high production. It can occur only when the demands on the economy are somewhere near the capacity of the plant and available labour force to supply them.” The obvious is not always true. Current experience in Britain, the United States and other Western countries proves that severe price-inflation can coincide with comparatively low production, high unemployment and idle plant. It can also coincide with absence of overall growth.

Inflation will be looked at more closely in later chapters. Here it is enough to remind ourselves that the theory of economic growth is barely two decades old; that it is very far from scientifically established or universally accepted in a clear or stable form; that it has yet to be fully tested over long-term, varied economic experience; and that it has never quite disentangled itself from Keynesian theory of business fluctuations and monetary effects.

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