Monday, November 21, 2016

"Where Does Growth Come From?"

What Are the "Ingredients" for Economic Growth? by Scott A. Wolla, from Page One Economics at the St. Louis Fed:
Where Does Growth Come From?

Three factors can create economic growth: more capital, more labor, and better use of existing capital or labor.
Three factors, period. End of story. Nothing remains to be said.

But guess what? I don't agree. (Surprise, right?)

This explanation, Scott Wolla's explanation, is standard fare. You read the same story when you read about the Solow Growth Model. You read the same story from economists and non-economists alike. But something's missing.

Something's left out: Sometimes, times are good. Sometimes, times are hard. They attribute this to varying efficiency. I say they left something out: Good times arise from financial conditions.

When you mention good times, kids like Noah think of the 1990s. But someone ten years younger (Noah says) cannot imagine why. Someone a little older, like my neighbor, thinks of Reagan and the 1980s. Older yet, Jude Wanniski thought that you have to have lived in the 1950s and 1960s to have experienced a good economy.

Good in the '50s and '60s, not so good in the '70s, better in the '80s and '90s, then not so good again. These anecdotals find some measure of support in the numbers:

Graph #1: Economic Growth (gray), Trend of Growth (red), and Trend of Trend (black)
Do you still think these variations have something to do with Scott Wolla's three factors?

Of course!

But do you think no other factor plays a role? You'd be pushing your luck to make such a claim. You'd be saying "evidence of no" where you should say "no evidence of". You'd be making assumptions about unknowns. You could make such a claim only if you refuse to look beyond those first three factors.

I know, I know: There's nothing else in the Solow Growth Model. There's capital, and labor, and efficiency, and that's it. But the Solow model is not the economy. The model is a simplification.

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