Economic Growth is frequently pitched as the objective of politicians (esp those on the right) and their nations. But much of what we perceive as economic growth is actually an illusion. Notably…..
1a) Faulty Measurements – GDP
Economic growth is usually measured as an increase in GDP, where GDP is a measure of aggregate economic activity of the circulation of money. GDP has several well known flaws, most famously noted in the “broken window fallacy” where the expenditure to fix a broken window counts as a positive boost to GDP where in fact the society is actually worse off, having consumed resources merely to return the window to a previously achieved state.
However this anecdote is indicative of a larger problem – that GDP measures something equivalent to revenue (activity this year) without attempting to measure net income (profitability) or asset position (did this activity make us richer or poorer; what one-time assets were consumed to create this years income activity)
Alongside GDP, there should be a second measure, a Net Asset Position (NAP) value, which is the economic value of all assets within the relevant area. Including clean water, clean air; non-renewable resources such as oil, iron ore, lithium ore; renewable resources such as trees, both for their wood and their oxygen generation; diverse and thriving eco-systems like jungles and reefs; built infrastructure such as hospitals, schools, roads and railways; power stations, hydro and wind farms. In such an NAP measure, burning the oil to run a Formula 1 motor race correctly becomes seen as a reduction in net wealth, rather than the boost to GDP under which it is currently accounted. But converting steel and construction energy into a wind farm, creates a net increase in wealth once the future power generation capacity is added to the NAP.
https://ourworldindata.org/the-missing-economic-measure-wealth
1b) Faulty Measurements – Inflation
For reasons which we will return to later, the value of money (most currencies including US dollars, UK pounds, Euros, etc) is gradually decreasing over time. This presents itself to us, as a gradual increase in the price of almost everything, when measured in money/currency.
So for example, this chart of the price of gold at includes a selectible button labelled “Inflation Adjusted”. With that button selected, we can see that gold was at its most valuable in 1980. Without that button selected, we can see that the nominal price of gold, measured in dollars, was higher in 2011. However, in the intervening 31 years, the value of the dollar was falling, so that in “real” terms, that is inflation-adjusted terms, the value of gold in 2011 was not as high as in 1980.
Various organisations calculate a measure for price inflation each year, which produces a “deflator” which is a multiplication factor for converting a current money value into a “real” or “constant” value for previous years. Any statistics/charts of prices, or incomes, or GDP or any other value measured in currency, which does not include an adjustment for inflation will be misleading, and tend to overstate the progress made by the statistical indicator.
2a) Externalities : Empire and Slavery
Much of the historical growth in wealth and economic activity is based on the import of value (raw materials, cheap overseas labour) into the area whose growth is being measured.
From the perspective of Spain, the colonisation of the New World, and appropriation of its gold will have looked like a massive boost to the economy of Spain. However, that boost neglects to measure the loss in wealth to the american territories overrun by the Spanish. Moving the gold to Europe did not cause any net increase in wealth of the overall imperial Spain plus colonies area. All it did was to transfer that wealth from invisible foreigners to highly visible Spaniards in Spain.
I distinguish here between the appropriation of empire, which is a non-consensual transfer of resources into the imperial homeland, and foreign trade which is a consensual exchange of value between geographically dispersed territories.
In a similar vein, the widespread use of slaves by the USA in the 18th/19th centuries, will have appeared to be the source of an increase in wealth for the slave-owning people and slave-using nations. However, that measurement neglects to include an offsetting net loss of wealth for the slaves themselves, and the nations they were taken from.
2b) Externalities : Non-renewable Resources
As noted above, our current GDP measures of economic activity fail to account for the asset value destruction in consumption of non-renewable resources such as oil, metal ores, fertile land, and clean air and water.
The owner of the oilfield or mine, does not pay anyone for each barrel or ton extracted from the ground. The factory owner does not pay for the oxygen consumed in their furnace. In many jurisdictions, the factory owner does not pay for the air and water pollution they generate. In assuming that such resources are free externalities, our GDP measurements cannot tell the difference between the power-generation investment of building a windfarm and the ephemeral waste of a motor race. In both cases, resource assets are consumed to generate economic activity, but in only in the first case is a new asset created. Because these “natural” resources are treated as being free, there is every incentive to use them up as quickly as possible, both to juice our current activity measures and to get in before someone else does.
Consumption of non-renewable resources looks like growth, when actually it is a net decrease in wealth, unless offset by creation of a useful asset.
2c) Externalities : Government Debt
All the governments of the western world have massive debts, implemented by sales of government bonds. USA (2019) $22trillion. UK (2018) £1.8trillion.
Borrowing money (taking on debt) is a convenient way for governments to spend more money than they have, without the politically awkward options of putting taxes up, or reducing social expenditures. Where government borrowing/debt was used to create income-generating assets, that might be justifiable. However, most government debt is used to fund vote-winning bribes like tax cuts and/or increased social expenditures. That is not to say that tax cuts and social expenditures are bad, but merely that funding them via debt shows that they are intrinsically unaffordable.
In almost every case, these government bonds are never repaid, but merely rolled over, with new borrowing being used to repay the old debts as they become due. In most cases, the new borrowing is larger than the repayments, so the total debt continues to rise.
Theoretically, the total debt can continue to rise, until the interest payments on that debt are the same size as the total tax income of that government.
Few analysts believe these debts will ever be fully repaid. Unlike a commercial organisation, a nation is not seen as able to “go bust”. So long as a nation can continue to tax its citizens, some attempt at future debt interest payments can be made.
However, in the current situation where the total debt continues to rise, the generation that will or might repay the government debt continues to be some unspecified future generation. That unknown future generation would need to consume vastly less than they create, in order to make any headway at repaying the debts (via their tax payments). Despite the fact that up until now every generation consumes vastly more than we create, which is how we come to be generating the debt in the first place. Effectively, the current generation is living higher on the hog by appropriating part of the wealth of their children or grandchildren.
Thus, part of what we perceive as current economic growth, is actually the consumption of the asset wealth of future generations.
3a) Distortion of the Economy : Interest Rates
Because it is politically easier for governments to borrow money, than to tax the voters, or reduce social spending, governments (of both left and right) tend to borrow, by selling bonds. How much that will cost the government in the longer term, depends on the rate of interest payable on those bonds.
Therefore it is in the interest of the government to suppress the prevailing interest rates on borrowing, in order to reduce the sum of all the interest they owe, and stave off the day when the sum of all the interest the government owes reaches the level of their total taxation income.
Governments suppress interest rates via their central banks offering short-term loans to commercial banks at the rate of interest they are targeting (the so called “base rate” or “discount rate”). Commercial banks are happy to borrow from the central bank at the artificially low rate, because they believe they can use that borrowed money to make a percentage profit larger than the artificially lowered interest rate they are paying to the central bank. This acts as a subsidy to commercial banks.
Because the central bank is offering short-term loans at cheap rates, this undercuts every other lender, who cannot charge significantly higher rates, without losing all their business to lenders who are only charging just a little bit more than the central bank offered rate. Thus all interest rates tend downwards towards the rate offered by the central bank.
In an unfettered market, a higher rate of interest would likely to be more appropriate in difficult times, to take account of possible bankruptcies, trade wars, market crashes, defaults, etc. But because a central bank can create money from nothing, it cannot go bust, even if it doesn’t get repaid for many of the loans it made.
3b) Distortion of the Economy : Quantitative Easing / Money Printing
Quantitative Easing (QE) is the euphemism for the creation of money from nothing, by central banks. It can also be referred to as “money printing” although that is an anachronism as the newly-created money is not printed as paper banknotes, but rather created as digital records of bank accounts in their computers. But the principle is the same – creation of new money from nothing. The scale of this money creation is in the tens of billions per month.
At the time of writing (2019) this new money has been used by the central banks of USA, UK, and the EU to purchase government bonds, although the UK and EU also bought some company bonds, and Japan also bought the stocks(shares) of Japanese companies.
The stated aim of such programmes is to maintain a specific level of inflation (we will return later to whether that is a good idea). However, these programmes have several other effects.
The initial effect of the government purchase of bonds is to support the price of the bonds. As with any situation where there is a large purchaser of an asset (particularly one that doesn’t care much about the price) the price of the target asset (bonds in this case) goes up. Sellers of bonds are confident that the central banks will continue to purchase bonds, and therefore the perceived value of the bonds is maintained. Some other market participants may even purchase bonds themselves, just in order to be able to resell them to the central bank bond purchasing programme.
Without the central bank support of bond prices via purchases, those bond prices would tend to decline as other market participants have increasing doubts about the ability of governments to continue to make the interest payments on their outstanding (and ever increasing) debts.
A second effect of bond purchases is a net increase in the wealth of people and organisations who are the prior owners of the bonds. That net wealth transfer from the central bank is the difference between the artificially higher value of the bonds, and their real market value if the central bank wasn’t creating billions of money to buy them.
Owners of bonds tend to be financial services companies, private pension funds, wealthy individuals, and foreign companies/governments who want to hold an easily tradable asset in the relevant currency of the bond. We can see that the wealth transfer from the central bank will be predominantly towards people who are already wealthy, both private individuals, and the recipients (typically older, from well-paid careers) of private pensions.
Note that the public (government-funded) pensions for poorer people do not typically have a pool of income-generating assets (bonds, stocks/shares, etc) like a private pension fund does. Government funded pensions are paid out from current taxation income (yes, government pensions are a ponzi scheme).
Where quantitative easing is used to purchase stocks/shares instead of bonds, the same wealth transfer effect occurs. Again, it is the value of assets typically owned by wealthy people (or their pension funds) which are artificially increased.
A third effect of the money creation to fund bond and other asset purchases, is to dilute the value of all the other money (of that currency) already in existence. The sellers of the bonds to the central bank now have the new money in their hands, to use as they will. In the economy as a whole, there is now more money bidding for the same amount of non-monetary things. The net effect of this extra money will be that the prices of everything will increase: bonds, stocks, food, rent, house prices, wages, education, everything. If you already own these things, you are no worse off. Your thing is worth more, measured in currency, but the currency is worth less by approximately the same amount. But if you don’t already own things, then everything you need to buy is more expensive. For some people, their wages increase at the rate of inflation, but in most jobs there is not a built-in inflation adjustment to wages.
When the central bank creates money from nothing, it appropriates the value created, from all current holders of that currency, and gives it to the prior owners of the purchased asset class. A net transfer of wealth from everyone towards the already wealthy.
4a ) Inflation / Deflation : Bank Loans
As well as the money creation from nothing of QE, the other route by which money is created, is via the initiation of a bank loan. In a sense, this is also creation of money from nothing, but it is different in that there is a matching debt also created. The person borrowing the money has the new cash, but also a matching debt to the bank. The bank also has two transactions on their books, a transfer out of the loan advance, and a future repayment of the loan. When the loan is repaid, the new money will disappear.
If the borrowed money is used to create an income-generating asset, like a company or a factory, then the net increase in money of the nation, is being matched be a net increase in assets within the nation. The value of money should stay approximately constant. Even where the money is used to build a bridge or a school (which generate no direct income) if the measurement of the value of national assets is well designed, then again the increase in assets is matched by the increase in money.
If the lifetime of the created asset is longer than the period of debt/interest repayment, then the net asset position of the nation should improve, as the asset still exists after the debt is repaid, and the new money has disappeared.
However, if the borrowed money is used for consumption instead of investment, for example to pay for a holiday, then there will not be any net increase in national asset position. During the period of the loan, more money will be bidding for the same pool of assets, thus causing inflation.
In practice, the total value of outstanding loans of commercial banks is always getting larger. Not all loans are used to create income-generating assets, and thus there is more money bidding for the same assets, and thus the prices of everything tends to increase.
4b) Inflation / Deflation : Technology and Efficiency
Counter-acting the inflationary effects of an increase in the money supply, is the deflationary effect of technology improvements, and other efficiency gains.
The most obvious example is in computing. Over the last 35 years, improvements in computer technology have caused a regular and massive decrease in the price of computing. As noted by Moore’s Law, the calculating power of computers doubled every two years between 1975 and 2012. At the same time, the price of a desktop computer was either static or falling. Any product where computing was a major factor in its production got massively cheaper, such as the global connectivity and availability of services like Skype, Facebook and Netflix.
Given the ubiquity of computing in business, this massive productivity surge should have caused massive price drops in multiple product sectors, a surge of global deflation.
In practice, the productivity gains were partially extracted as profits to innovator/exploiters like Bill Gates and Mark Zuckerburg, but more universally the non-monetary experiential wealth of billions was enhanced.
Even so, on a like for like basis of the same products, there should have been huge deflation since the general uptake of computers and the internet in the mid 80’s. But we have not seen that.
4c ) Inflation / Deflation : Offshoring
Since around 1995, many companies in the west have moved some aspects of their production or support operations to places like China and India in order to take advantage of lower wage costs in those countries. This reduction in the cost of production should have led to significant price reductions for the finished products and thus to deflationary effects on the importer economies as a whole.
4d ) Inflation / Deflation : Where is the deflation?
The composite effect of technology and offshoring should have caused massive deflation in the west, but that has not been the experience. So what happened?
If you are a holder of currency, then deflation is good for you. Your money becomes worth more, and you can buy more with it.
However, if you are in debt, then deflation is bad for you. With deflation, the “real” value of your debt increases, and becomes harder to pay. A debtor prefers inflation, where the “real” value of their debt falls. People with home mortgages during inflationary 1970’s and 1980’s experienced this, where the mortgage debt had become a trivial amount of money by the time the mortgage term expired.
The same applies to governments. Every extra percentage point of inflation, is a percentage point of interest that won’t need to be repaid. Because of their huge debts, governments of both left and right are incentivised to generate inflation, as a more electorally tolerable way to take money from the taxpayers, than outright taxation, debt, or service cuts.
4e) Inflation / Deflation : A Green Perspective
Inflation encourages short term consumption, as the future value of money is expected to be lower. By contrast, deflation encourages holding onto money as the future value of money is expected to be higher.
A green economist should prefer the latter, as counteracting the incentives to exploit and consume the worlds resources as fast as possible.
For similar reasons, we should avoid massive government indebtedness as also encouraging current consumption in preference to future well-being.
We should prioritise asset-based financial reporting rather than revenue-based (GDP) type reporting, to re-assert the importance of long term sustainability over short term consumption.
We should implement taxation measures to ensure that exploitation of non-renewable resources has a cost to the extractor, in the form of a repayment to the community of the value of the resource. This avoids the incentives towards as-fast-as-possible use of non-renewable resources.
We should avoid government or central bank interference in interest rates, money printing and asset purchases. Both to avoid the unearned wealth transfers to the rich, and to allow malinvestment of the past to be liquidated. We recognise that may cause a deflationary event as the currently unsustainable practices are unwound.
Postscript
Some speculations based on the above…
- the 2008 crash arrived at around the time that Moore’s Law was fading, when most of the productivity gains of computers/internet had been had.
- we concurrently have massive deflation caused by computers/internet/offshoring and massive inflation caused by money printing and ballooning debt. They are mostly offsetting each other (2000-2019). When the productivity gains are done, then inflation kills the west, just like it has crushed everywhere else that doesn’t own the tech companies.
- the “live now, pay later” mindset which prefers inflation, is also good news for bankers, who make a profit every time someone buys something they cannot currently afford, using a loan. It is in the commercial interest of bankers to encourage debt-based spending, because that is how bankers get paid.
RJ7 (2019)