Why is Growth Fixed?

Something like the earthquake, tsunami and nuclear crises that have hit Japan can’t really pass without mention. But I have no knowledge of geology, oceanography, applied nuclear physics or crisis management, so I will content myself by extending my sympathies and condolences and offering a little economic analysis.

Chris points us towards a paper by Ilan Noy and colleagues which estimates that even terrible natural disasters “do not display any significant effect on economic growth.” Which seems surprising given the horrors visible in Northern Honshu. Taken together with this old paper by John Landon Lane and Peter Robinson which shows little long run variation in rich world growth rates, Chris argues trend economic growth may be so deeply embedded in institutions that it is much harder to change than is often supposed.

This is an interesting theory, but I would like to add a little more nuance to it. Long run economic growth is composed of the emergence of new sectors and the improvement of existing ones (plus a negative contribution from the exit of obsolete industries). Imagining how disasters effect this is the key to understanding why even colossal disasters have small effects.

For illustrative purposes, we can look at the first half of the twentieth [edit, see comments] century. Some recent preliminary findings (so this should be taken with a pinch of salt until it is peer reviewed and published) presented to me show that total factor productivity growth was largest where you would expect it to be; Electrical Utilities, cars and their feeder sectors, like rubber. However, this is not where most economic growth came from.

The most important sectors were incredibly boring. Wholesale and retail trade, foods, farming and construction all added much more to the stock of human wealth than the Model T ever did in this period. Looked at like this it becomes clear why economic growth is difficult to interrupt even for a large earthquake. A lot of economic growth comes from geographically dispersed industries, which rely a great deal on tacit knowledge over physical infrastructure, or where the replication of their infrastructure is intrinsic to the business.

If we engage in a bit of counterfactual history, it is also possible to imagine disasters having small, inconsequential effects even were, say, a 8.9 magnitude earthquake to hit Detroit in the 1900s. If Henry Ford and William Durant of GM were to be both killed, and their workshops ruined the knowledge on which they built their empires would not be destroyed. Knowledge is key, even in capital intensive industries.

Over 1000 automobile companies were set up in the US in the last 110 years, most (or is it all now?) have gone bust. Knowledge is very difficult to destroy, even if it is hard to create.The tacit knowledge in carriage making which fed the early auto industry and the market for automobiles in the US would remain unless something truly Cormac McCarthyesque were to happen. Most industries would continue trundling along making the world richer in little ways all round the world, and the 20th Century’s leading sector would just be a little delayed and that delay would hardly show up in the GDP data.

However, this raises one interesting thought. Economic growth may be very difficult to adjust via policy because policy has been aimed at the wrong industry. David Cameron may get a hard on form the thought of a new Silicon Valley in the East End, but most people in the east end want cheap, modern housing and retail goods. We don’t need to make small sectors lots more efficient, that’s really hard. We should focus on making large sectors a little tiny bit more efficient, that would be construction, retailing and business services.

I hate to side with that man against Chris, but there may be ways to improve economic growth through cutting red-tape in the UK. Planning permission severely hampers home building and the expansion of retailing, cutting that wouldn’t do much for localism, but it would almost certainly boost GDP.

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6 thoughts on “Why is Growth Fixed?

  1. “For illustrative purposes, we can look at the first half of the nineteenth century. Some recent preliminary findings (so this should be taken with a pinch of salt until it is peer reviewed and published) presented to me show that total factor productivity growth was largest where you would expect it to be; Electrical Utilities, cars and their feeder sectors, like rubber. However, this is not where most economic growth came from.

    The most important sectors were incredibly boring. Wholesale and retail trade, foods, farming and construction all added much more to the stock of human wealth than the Model T ever did in this period.”

    Well, yes, I suppose so, given that the Model T was a 20th century invention…..

  2. To be honest, I’m not sure what I was saying in that post.
    There is the nihilist view that nothing much will make a difference. But there’s two other possibilities.
    One is a point about measurement; the noise-signal ratio in GDP data is so high that it just doesn’t permit much meaningful inference.
    The other is that, altough there might be growth-enhancing policies, there are institutional constraints that prevent them being adopted. Intuitively, I agree with you and Tim that some policies such as planning reform must increase growth. But this just raises the question of why, if this is so, have they not been implemented already?

  3. “some policies such as planning reform must increase growth. But this just raises the question of why, if this is so, have they not been implemented already?”

    That growth isn’t the main priority?

    For example, we can make a strong (perhaps not perfect but strong) argument that higher VAT and lower capital and corporation tax would increase growth. But there are many who would reject such a policy even if they were convinced it were true, on the grounds of “fairness”.

    Planning, meet NIMBY etc….

  4. I’d argue that planning is an interesting example of a policy arising from the intellectual discourse of its time combined with institutional inertia and vested interests. The current framework dates from the halcyon days of central state planning immediately following WW2. There’s legions of people – planning officials, lawyers and consultants – with a vested interest in ensuring that it remains in place.

    There are reasons for the retention of the current system on the grounds of ‘fairness’. Someone else’s development can impact on the value of your property, and if you have insufficient money to make a claim against that developer you’re stuffed. Even if we ditched the system tomorrow, without reform of the way in which injunctions work it’d still be possible to tie up developments for years on legal matters.

    I’d suspect that the retention of policies like planning which are antithetical to growth is a combination of the above factors – vested interests mixed with apparently highly contentious barriers to their removal.

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