Why Is Economic Growth So Hard To Plan?

Today’s Quote of the Day featured a discussion of economic growth, how the planner’s problem can lead to the growth of a predetermined variable but not necessarily economic growth.  History is rife with examples like this (heck, the book I linked to in the QoD is filled with examples).

So why is planned economic growth so hard to achieve?  The answer is as obvious as it is simple: there is no magic formula, no silver bullet, for achieving growth.  Even Robert Solow, the grandfather of economic growth modeling himself, said “[I]n real life it is very hard to move the permanent growth rate; and when it happens…the source can be a bit mysterious even after the fact.”  There have been many who have run tests trying to determine what the factors are (including Xavier Sala-i-Martin’s 1997 paper “I Just Ran Two Million Regressions“), but the results are just a jumbled mess; hard to interpret and even harder to build policy off of.  The results tend to be rife with omitted variable bias (for example, Sala-i-Martin finds that Islam tends to correlate with economic growth.  Well, is it Islam that is driving the growth or some omitted variable that is occurring along with Islam?).

Another issue that arises is: how to measure economic growth?  There are many ways to measure it, but none are perfect.  GDP (and its derivative, GDP per capita) are among the most common, but they suffer from the same “output vs economic growth” problem I discussed above.  GDP is a measure of the final output of all economic actors within a nation.  It makes no distinction between economically beneficial output and non-economically beneficial output.  For example, let’s say there are two countries: Country A produces \$100 of goods its citizens consume (things like housing, food, automobiles, etc).  Country B produces \$100 of goods no one uses (things like “a road to nowhere”).  Both countries have 10 people in them.  Mathematically, the two countries would have the same GDP (\$100) and the same GDP per capita (\$100/10 = \$10 per capita).  However, it would be a gross mistake to claim the two are identical economically speaking.  Country A is filled with welfare-enhancing goods.  Country B has no welfare-producing goods, only welfare-detracting goods.  So we need to be careful with our measurement devices lest we fall back into the Planner’s Problem (as an aside, this is the exact issue the USSR and Maoist China ran into.  Both focused on increasing their GDP without any regard to producing economically useful goods.  This is why, despite similar (and sometimes higher) GDP growth rates, the USSR and Maoist China remained so poor compared to the US).

While GDP is just a single example, this is true regardless of what measure one wants to use.  They all have the same issues and all run the policy risk of simply increasing the predetermined variable vs actually generating economic growth.

Since the goal of all economic activity is to improve welfare, and welfare varies from individual to individual, region to region, and even country to country, there cannot be any any single, unified policy agenda to generate growth.  Even the institutions I heartily endorse (free trade, open borders, rule of law) can run into the same planner’s problem issues if treated as a policy goal instead of an organic institution.

There are many questions in this topic and people far smarter than I can ever hope to be have been struggling with them for over a century.  If there is any takeaway from this post, it is to beware anyone selling a “miracle cure for growth.”  They are most likely con men.

One thought on “Why Is Economic Growth So Hard To Plan?”

1. Destruction of capital doesn’t matter; it is not part of GDP accounting. The government defines its spending as useful GDP. Every item is useful to the society when the government buys it, even if it is designer filing cabinets or decorated Dunkin Donuts. Even if bought and immediately thrown away.

Government spending always adds to GDP dollar for dollar spent, and it has a 1.5 to 4 multiplier, so it is one of the most amazing and effective activities which exist. Government doesn’t really spend money, it makes money, somewhere, somehow.

Printing money to support government spending is the obvious thing to do. We never have to pay it back, because we owe it to ourselves, and every dollar gives someone a job and pulls us out of economic distress. The power to create money is simply the power to produce prosperity, if only we had the courage to do enough printing.

Inflation is not a problem, because it unsticks sticky wages and encourages people to spend their money now rather than wait for it to evaporate. This creates economic activity and GDP now rather than in the imaginary future. If people don’t notice their wealth is evaporating, then it isn’t stealing. If a tree falls in the forest and no one hears it, it didn’t really make a sound.

I wish all of the above were sarcasm, but it is official accounting and economic policy for the US, UK, and EU.

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