Little Changes Add Up
John Cochrane — who blogs as The Grumpy Economist but doesn’t seem all that grumpy — wrote a paper on economic growth last year as part of a project to design presidential debate questions.
Sadly, the candidates chose to talk about other issues such as finger length and personal energy levels, but Cochrane’s paper is still useful.
I’ll discuss it briefly, but everyone should read the full version. (It is not at all technical, and you will learn much.)
How an Extra 1.5% Tripled Your Standard of Living in 65 Years
He begins by showing how small changes matter a great deal in the long run. The economy grew by over 3½% from 1950 to 2000. Since 2000, the economy has grown at about half that rate, or 1.7%.
And therein lies the reason that incomes have been so punk for so many Americans:
Small percentages hide a large reality. The average American is more than three times better off than his or her counterpart in 1950. Real GDP per person has risen from $16,000 in 1952 to over $50,000 today, both measured in 2009 dollars. Many pundits seem to remember the 1950s fondly, but $16,000 per person is a lot less than $50,000!
If the US economy had grown at 2% rather than 3.5% since 1950, income per person by 2000 would have been $23,000 not $50,000! [emphasis mine] That’s a huge difference. Nowhere in economic policy are we even talking about events that will double, or halve, the average American’s living standards in the next generation.
I don’t know about you, but to me, those are stunning numbers for several different reasons. I was born in 1949, so GDP per person has more than tripled in my lifetime. That’s in constant dollars, so it isn’t just “growth” by inflation.
Yet this tripling would not have occurred if the economy had grown at 2% a year instead of 3.5% during my lifetime. That extra 1.5% made an enormous difference.
In fact, the difference is even greater.
GDP per capita does not capture the increase in lifespan — nearly 10 years — in health, in environmental quality, security and quality of life that we have experienced. The average American today lives far better than a 1950s American would if he or she had three rather than one 1950s cars, TVs, telephones, encyclopedias (in place of internet), or three annual visits to a 1950s doctor…
Those 1950s doctor’s visits now seem like Stone Age medicine. And that doesn’t take into account mobile phones, Google maps, and a plethora of other things that make our lives better because the growth of the economy made us better able to afford them.
But even these less quantified benefits flow from economic growth. Only wealthy countries can afford environmental protection and advanced health care. We can afford to worry about global warming. India worries about 600 people per toilet, emphysema from burning cow patties, and easily treatable parasitic infections. Our ability to defend freedom around the world — even if we are wise enough to do it sensibly — depends on robust economic growth.
If GDP had grown at 2%, not 3.5%, we would only be able to afford half the military we have today. The immense improvements in the quality of goods and many services we have today are part of the engine of economic growth.
This is why the recent years of subpar growth are a big problem.
Low Growth Is a Trap
It isn’t just the current feeble recovery: we are now almost a full generation into a low-growth era that marks a departure from most people’s prior experience.
It’s no wonder so many folks are discouraged and angry. (And by the way, we’re growing faster in the US than they are in Europe and Japan.)
Some economists will argue that the last century was an aberration. Robert Gordon is a good example. Watch his TED Talk if you’ve never seen it. He believes a handful of one-time breakthroughs (electricity, automobiles) accounted for most of the economic growth we now think should be normal.
I disagree with Gordon — and will attempt to rebut him in my upcoming book — but I have to admit he makes some very good, valid points.
The short version of my view is that I think we’re on the cusp of changes that will be just as revolutionary as electricity and that will boost our growth considerably — even by the standard measure of GDP, which we know misses so much. This is why I am optimistic about our future.
Cochrane points to the official Congressional Budget Office long-range outlook, which assumes 2.2% growth from now through 2040. That would be an improvement over the recent past, but it’s still historically low.
If you change that assumption from 2.2% to 3.5%, total GDP in 2040 will be 38% higher. That GDP boost means tax revenues will be 38% higher, and much of our debt problem will disappear. Shades of Newt Gingrich! Conversely, Cochrane notes that 1% GDP growth over that period would yield a 26% drop in GDP and tax revenue, leaving us in a deep hole.
On the other hand, there is no reason to think 3.5% growth is the ceiling. With a few changes we might be able to boost it even higher. Cochrane says what I have long believed: Rising productivity is the key to economic growth.
The more each human can produce, on average, the higher everyone’s standard of living can rise.
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