The Reason for Desiring Economic Growth

Checking my blog stats the other day, I noticed that one of the "traffic sources" was a google search for the reason for desiring economic growth is to...

Now, one of the things that's clear in my mind is why we might desire economic growth. So I thought I'd be explicit about it.

Lots of people complain that GDP is not a good number for various reasons. That may be. But it's the number we have. Making the number better is off-topic at the moment.

So what is GDP anyway? It's a measure of what we produce in a year. It's a way to measure the "size" of the economy. And we want it bigger because...

Nope. Not yet.

GDP = Gross Domestic Product
"Gross" = all of it. ("Gross" in this context does NOT mean "yucky".)
"Domestic" = within our country.
"Product" = the stuff we produce.
GDP is a measure of all of the stuff we produce within our country. In a year.

Now I can tell you why it's important. It's important because the total value of what we produce in a year is equal to the total value of our income in a year. GDP = GDI, where the "P" is "Product" and the "I" is "Income".

So, why do we want more economic growth? Because we want more income.

You do want more income, don't you?

BCG81 said...

This is crude. I'm just throwing together a few pictures at FRED, in response to a comment from BCG81 on my old Kaminska and Unit Labor Cost post.

BCG81 said...

I agree it does not make sense to talk about a "correlation" between ULCs and inflation, because they're the same thing. But as I understand it, the reason *nominal* compensation is compared to *real* productivity is to measure the extent to which compensation can rise (as a result of compensation or inflation rising) without putting pressure on prices. You can't see that without holding output prices constant. Also, when using ULCs as a measure of international competitiveness, you want to see both cost (i.e., nominal i.e., labor share) competitiveness and price competitiveness (i.e., relative rates of inflation).

I don't know how to respond in words. The ideas are too big and too nebulous. It goes in interesting but turns to mush in my head. So I went to FRED.

This is crude because I'm just comparing labor cost to corporate profit.


Here's the "Unit Labor Cost" graph I showed in the old post:

Graph 1: Unit Labor Cost

Now if you wanted to compare that to something, you might compare it to Corporate Profit as a share of GDP:

Graph #2: Corporate Profit After Tax as a Percent of GDP

But that's not really a good comparison, for a couple reasons. First of all, the corporate profit measure is "after taxes". Why, I don't know. That's the popular measure though, at FRED. Type corporate profits in their search box and hit enter, and the first thing that comes up is Corporate profits after tax on a list that's sorted by popularity.

Whatever. The second reason...

Well, wait a minute. Let's look at the graphs.The first graph shows unit labor cost going up on a pretty straight path since 1980. That's labor cost, meaning wages and salaries (and benefits) before tax, as opposed to after tax. In addition, the taxes businesses pay on labor are added to that, if I remember right.

The second graph shows corporate profits after tax drifting possibly down until the mid-1980s, then rising from a low of 3% to a current high of over 11%.

From 1980 to the recent data, unit labor cost rose from about 60 index-units to less than 120. I don't know what the index-units are, but I can see that unit labor cost did not quite double since 1980. By contrast, corporate profits increased from 3% to over 11%. That's almost a fourfold increase, in less time than it took for the unit labor cost to double. Now... where was I?

The second reason these two graphs are not a good comparison is that Graph #2 shows profit as a percent of actual-price GDP. To make it comparable to Graph #1, we'd have to show it as a percent of inflation-adjusted GDP, like this:

Graph #3: Corporate Profits After Tax as a Percent of Real GDP

Now that sucker's going up.


I downloaded the data from Graph #3 and figured the average of the four (quarterly) values from 2005. That value is 9.72447382422837. (You should be laughing because I'm using all the digits.)

I used the average to create a version of Graph #3 that shows the data as an index with 2005 = 100, just like the Unit Labor Cost in Graph #1.

Here's the corporate profit data in blue, and the Unit Labor Cost data in red:

Graph #4: Unit Labor Cost (red) and Unit Corporate Cost (blue)

Here's the same data, just since 1980:

Graph #5: Unit Labor Cost (red) and Unit Corporate Cost (blue) since 1980

So, what's going up faster? What's driving prices up? Labor cost, they say. Not the blue one, they say. Well, maybe that was true in the Reagan years...


But, you know, maybe that's not so clear. Both lines are going up since the latter '80s. Let me do what I did in the old post, and show the data relative to "nominal" GDP -- GDP measured in the prices we actually paid to buy the stuff we bought:

Labor Cost (red) and Corporate Profit (blue) Indexes Relative to Actual GDP

Yeah, that red one? The one that's going down since 1960? That's the one they say makes prices go up.

It can't be true.


And now I can respond to BCG81:

I don't know about the things you said. But I know that any time you divide "nominal" something by "real" something, you are factoring inflation into the result.

And I know that after you factor inflation into something, the thing looks more like inflation than it did before.

And I know economists like to take these things with inflation factored in, and compare them to inflation, and say Wow, look at the similarity.

And I know that the similarity is created by the arithmetic. Not by the economy.

Notes on Debasement

In Milton Friedman's Money Mischief, in a chapter titled "The Cause and Cure of Inflation" we read:

So long as money consisted of specie (whether gold, silver, copper, iron, or tin) inflation was produced either by new discoveries or technological innovations that reduced the cost of extraction or by debasement of the currency -- the substitution of "base" metals for "precious" metals.

As long as money "consisted of specie" there were only two ways to create inflation, Friedman says. And debasement was one of the ways to create inflation.


From Price Fixing in Ancient Rome ( Mises Daily: Thursday, June 18, 2009 by Robert L. Scheuttinger and Eamonn F. Butler):

In order to attempt to deal with their increasing economic problems, the emperors gradually began to devalue the currency. Nero (A.D. 54–68) began with small devaluations and matters became worse under Marcus Aurelius (A.D. 161–180) when the weights of coins were reduced. "These manipulations were the probable cause of a rise in prices," according to Levy.

And again:

It would seem clear that the major single cause of the inflation [from Nero to Diocletian] was the drastic increase in the money supply owing to the devaluation or debasement of the coinage.

As with Friedman, here also the manipulation of the metal in money is offered as the cause of inflation, not the result. It's probably both, as everything in the economy has two sides. But what I'm saying is that manipulation of the metal, debasement, is a response to changing conditions in the economy. Note the prefacing phrase in the first excerpt from Scheuttinger and Butler: "In order to attempt to deal with their increasing economic problems..."

The problem doesn't necessarily start with government debasing the currency. You have to look farther back, before the debasement, to find the source of the problem.

It's a cost problem.

// Update 28 May 2013: Here's another one from Milton Friedman:

Since time immemorial, sovereigns -- whether kings, emperors, or parliaments -- have been tempted to resort to increasing the quantity of money as a means of acquiring resources to wage wars, to construct monuments, or for other purposes. They have often succumbed to the temptation. Whenever they have, inflation has followed close behind.

(From Money Mischief, Chapter 8: The Cause and Cure of Inflation)

Inside and Outside

From Mark Dow and Michael Sedacca at Behavioral Macro:

The Fed does not control the money supply; they control base money (or outside money), which is a small fraction of the broader money supply. In our fractional reserve system, the banks (loosely defined) control the other 90% or so of the money supply (a.k.a. inside money). And the banks have not been lending...

Pretty clear, about inside and outside money, and who controls what.

"Medium of Exchange" and "Medium of Account"

Two items from The Coinage of Ancient Rome:

During which emperor's reign was nearly all silver removed from Roman coins?

Gallienus. When Gallienus (253 - 268 a.d.) became Emperor, the coinage was already very debased. During his disastrous reign almost all silver was removed. He tried to disguise this fact by issuing copper coins which were silver-plated.

The standard gold coin of the early empire was the "aureus." How much gold did it contain?

About 1/5 oz. Unlike the silver coinage, Roman gold coins continued to be minted from good metal through the history of the Empire, undergoing only minor debasement. The weight of the aureus did tend to fluctuate a bit, but it was usually minted at 60 aureii to the Roman pound, which works out to about 1/5 oz of precious metal.

When wealth is excessively concentrated, little or nothing remains to serve as value in the everyday money of everyday folk. But the gold coins, that's a different matter.

Trade Agreements, Trans-national Corporations and the Sovereignty of Nations

Today's post has been rescheduled for tomorrow, to free up your time to read the above-titled post at Another Amateur Economist.

When you hear complaints of weak leadership, remember this:

In the half century before Diocletian, there had been a succession of short-reigned, incompetent rulers elevated by the military; this era of weak government resulted in civil wars, riots, general uncertainty and, of course, economic instability...

To this intellectual and moral morass came the Emperor Diocletian and he set about the task of reorganization with great vigor...

Since money was completely worthless, he devised a system of taxes based on payments in kind. This system had the effect, via the ascripti glebae, of totally destroying the freedom of the lower classes — they became serfs and were bound to the soil to ensure that the taxes would be forthcoming.

Excerpts from Price Fixing in Ancient Rome (Mises Daily: Thursday, June 18, 2009) by Robert L. Scheuttinger and Eamonn F. Butler. (I added the link to Wikipedia.)

The double-sided excuse

At Mike Norman Economics, Tom Hickey links to Erroneous Use Of The Sectoral Balances Identity [Updated] by Ramanan.

Ramanan reviews Andrew Lilico's Can public sector austerity coincide with private sector austerity?

Ramanan's post is impressive. Andrew Lilico's is not.


Lilico writes:

When we talk about "private sector deleveraging" what do we mean? We mean things like households paying off loans to the bank, or corporates paying off bonds or other loans. The vast, vast majority of such loans are loans private sector agents make to each other. So for every dollar reduction in borrowing made by one household or company, there is one dollar fall in savings by other households and companies.

(Forgive me my Americanisms. Andrew Lilico thinks in British pounds, but I think in dollars. Two places I had to change his word "pound" to "dollar" to help me think.)

Ramanan astutely observes:

Lilico confuses the terms borrowing and saving

He certainly does: For every dollar reduction in borrowing made by one household or company, there is one dollar fall in savings by other households and companies.

If only. If the reduction in demand (caused by the reduction in borrowing by some) was counterbalanced by an increase in demand caused by the reduced saving of others, there need be no recession, no output gap, no increase of unemployment.

Andrew Lilico's error is comparable to Eugene Fama and John Cochrane's as described by Paul Krugman:

Fama and Cochrane are asserting that desired savings are automatically converted into investment spending, and that any government borrowing must come at the expense of investment — period.

But in Lilico's case, the error is created by his use of the word "savings" when the correct word would have been "lending": For every dollar reduction in borrowing made by one household or company, there is one dollar fall in lending by other households and companies.

That much is true. But a reduction in lending is not the same as a fall in savings. A fall in savings implies money moving out of savings and into circulation without an act of lending. It implies a dollar-for-dollar substitution of demand by savers in the place of demand lost when spenders borrow less.

Lilico's simple word-substitution error explicitly describes this dollar-for-dollar shift in demand. Since it is dollar-for-dollar (or pound-for-pound) as Lilico describes it, GDP does not fall as a result of the reduction in borrowing. Output does not fall.

Ramanan writes:

The most fundamental error of Lilico of course is that he holds output constant in his entire argument. When discussing a scenario with sectoral balances, it is also important to keep in mind the behaviour of output.

Amen to that.



Ramanan also points out that

Lilico’s argument seems to think of the budget deficit as exogenous – i.e., under the control of the government but a careful study reveals that this ain’t so.

Yeah... But this depends on one's point of view. The people who call for austerity in government spending obviously think government spending can be cut and cut again. And obviously it can be done: It is being done. So I think Ramanan's argument here is weak. Remember, the object is always to convince people who disagree. Never only to preach to the choir.


My criticism of Andrew Lilico's article is unlike Ramanan's.

Lilico describes the sectoral balances identity:

...whatever the government doesn't borrow from the private sector in its own country it must be borrowing from foreigners.

He calls this "trivial". Then he allows a simplification: "we assume the position relative to foreigners doesn't change." Now the trivial has been reduced to pristine simplicity:

That implies that any reduction in government borrowing must precisely be matched by a rise in household borrowing. Conversely, any fall in household borrowing must be precisely matched by a rise in government borrowing.

Couldn't get much clearer than that. Even I understand it: A given economy, with its particular monetary balances, requires a particular level of borrowing for markets to clear. Notice in the above excerpt only borrowing is considered; not lending.

But Lilico says "the entire argument is utterly confused" from the start. From the off, he says.

Lilico says that private-sector borrowers essentially borrow only from the private sector. Not from the government, he implies out of the blue. Allowing the same simplification Lilico allowed above, let us say *all* private sector borrowing originates in the private sector. So when we speak of private sector deleveraging, he says,

The net change in the indebtedness of the private sector as a whole, relative to ... the government ... is zero.

Now he brings in lending, thoroughly confusing the issue:

Within the private sector, households could pay off all of their debts to each other, and that would (in an accounting sense) make no difference whatever to the net lending of the private sector as a whole to the government.

The goal of the sectoral balances approach is not simply to separate debt by sector. The goal is to see and understand what happens in the economy. In order to see and understand what happens, it is helpful to keep the sectors separate. Adam Smith did something similar when he identified the categories we call land, labor, and capital.

Andrew Lilico's logic is painfully out of focus. Reaching for a conclusion, he writes:

That clever-sounding national accounting identity at the start, once we ignore the external sector, says nothing more than that what the government borrows from the private sector is equal to what the private sector lends to the government

In Smith's day, Lilico would have been calling it foolish to separate labor from capital because what capitalists pay to labor is equal to what labor receives in payment.

Reading the new issue of Discover

In the recent Discover magazine I turn the page and find this:

Improve Medical Research, Scrap Funding Model

For nearly seven decades, federal agencies and many private funders have financed medical research through competitive grants to individual scientists who submit proposals for particular projects. This system is intended to match available funds with the best researchers and ideas.

But today's competition for limited grant money encourages overly safe research, aimed more at producing positive results to bolster future proposals than at breaking new ground. The current system discourages high-risk, high-payoff science...

I don't need to read any more. I already have a response.

The first paragraph sets the stage by describing the how and why of funding for science. The second paragraph describes problems with that system. Between the two is a transition phrase: "But today's competition for limited grant money..."

That's the problem, right there. The money. Problems with money create other problems. And then people write articles proposing to fix those other problems by changing the way things have been done for seventy years or more.

It may be a way to cope, but it does not solve the real problem.