From the October 2010 issue of Research Magazine • Subscribe!

October 1, 2010

The Myth of Growth

Both Keynesians and conservatives share in the mistaken belief that economies are by definition supposed to grow.

Over the past two years, Nobel Prize-winning economist and New York Times columnist Paul Krugman has been one of the most vocal and noticeable advocates of economic stimulus as a means of combating the Great Recession. He is by no means alone. Other Keynesians, too, have been unhappy about the $800 billion fiscal stimulus package passed by the Obama Administration in early 2009. While conservatives have been fretting about the massive U.S. budget deficit, Prof. Krugman declared that at least twice that amount would be needed to restore the economy to health.

Prof. Krugman's calculations are fairly mainstream and are based on accepted economic wisdom -- such as Okun's Law, first promulgated by Yale economist Arthur Okun back in 1962. Okun's Law claims that high unemployment creates an output gap, which means that the economy functions below its potential. Every percentage point above the natural rate of unemployment creates two percentage points of output gap. If natural unemployment in the United States is 4.5 percent -- and it is probably even lower -- than with the jobless rate at 9.5 percent or so currently, the output gap measures around 10 percent of GDP, or $1.5 trillion. Hence, to close this output gap and to bring the U.S. economy back to its productive potential, the government will need to nearly double the Obama fiscal stimulus package.

More from the Fed

More recently, Krugman also criticized the U.S. Federal Reserve for policy paralysis. The Fed suspended its aggressive quantitative easing in March, stopping its purchases of mortgage-backed securities. That was a good thing, according to Krugman, because it relieved financial institutions of non-performing assets and infused liquidity that could be used for lending. More recently, faced with a slowing pace of business recovery, the Fed announced that it would reinvest the proceeds from its maturing securities into long-dated U.S. Treasuries. This represented a compromise between those who feared that all that money being tossed out of helicopters represented an inflationary threat and those who claimed that in an environment of slow growth, sluggish demand and moribund bank lending deflation, not inflation, has emerged as the biggest threat.

Even with the existing 'modest' fiscal package, the U.S. budget deficit is likely to measure around $1.4 trillion in the current fiscal year, matching last year's record budget gap. It seems that continued monetary ease is a necessary condition for the U.S. government to finance its deficit spending even at its current levels, much less another fiscal package of nearly equal size.

U.S. debt by various estimates measures between $10 trillion and $14 trillion. It is likely to surpass 100 percent of GDP in nearby years, based even on the Obama Administration's (probably optimistic) forecasts. Krugman is quick to point out, however, that by the time World War II ended the Federal government had run up an even larger debt relative to the size of the economy. Yet, the U.S. economy easily grew out of its debt burden in the next decade. Krugman and other Keynesians are convinced that deficit spending doesn't matter as long as the money is used to bring back employment and therefore create the underpinnings for future economic growth.

On the other hand, the fact that the government has failed to fully close the output gap with a bout of public spending means that growth will remain sluggish for years.

Conservatives have attacked this reasoning because it proposes to vastly expand the role of government in the economy and cavalierly disregards the massive debt burden such policies generate. But there is another problem with this view: It assumes that economic growth is a normal condition of human society. In fact, both Keynesians and their conservative opponents share in the belief that economies are by definition supposed to grow and that if they don't it is the fault of the government that somehow adopted a set of "wrong" or "misguided" policies.

Na?ve Vision

This is certainly not supported by historical evidence. On the contrary, the opposite seems to be the case throughout human history.

We have become so used to growth -- and the rapid change, progress and capitalism's "creative destruction" which accompany it -- that we simply cannot envision a world without growth. But growth is rather an aberration in the history of civilization. Some 6,000 years of recorded history show that stagnation, tradition and drift have been far more typical of human societies. In fact, over the 2,000 years of the Common Era, Western civilization grew rapidly for three or four centuries under the Roman Empire and then again over the past 250 years, since the advent of the industrial revolution and the Age of Enlightenment. True, economic growth was especially rapid since the late 19th century, but that doesn't negate the fact that throughout the Middle Ages and the early modern period, growth was almost completely absent or extremely slow. Generation after generation of our ancestors experienced no discernible change in their economic condition or way of life.

In other civilizations, the contrast between periods of growth and stagnation was even starker and in many cases traditional societies were brought into the modern world and started to grow only because they came into contact with the rapidly advancing Western civilization.

Moreover, economic growth is not universally regarded as positive or unconditionally desirable. Just as greed, which has seen its reputation soar in modern times, growth was not always seen as such as good thing. Historically, human societies viewed growth and change with considerable apprehension. In the Middle Ages, commercial activity, technological progress and commercialization were frowned upon and discouraged. Money and wealth were not actively sought, and change and social dislocation were seen as too high a price to pay for a better life.

Rejecting Growth

Even in the West over the past century or so, discontent with our "growth civilization" has run high. Russian communism was, in many ways, a reaction against the dramatic capitalist growth Russia experienced in the late 19th and early 20th century, when the rapidly modernizing Russian Empire experienced the pace of growth that was comparable to, and in some ways faster than, the other emerging economic powerhouses of the time, Germany and the United States. Both the Russian Orthodox Church and the Left were opposed to the country's modernization and economic progress.

Russia is an extreme example. As a result of a communist takeover, Russia, for all its wealth and, a century ago, tremendous economic potential, has now become an underpopulated, underdeveloped and uncompetitive producer of raw materials, not a major economic power. Similar anti-capitalist, anti-growth ideologies emerged in the first half of the 20th century in Western Europe and North America as well.

China, where modernization spread rapidly from Hong Kong, Shanghai and other Eastern ports in the early 20th century, was similarly thrown back and held in a pauperized state for four decades by Mao Zedong and his cohorts.

But you don't need an ideology to stop growing. One of the best developed, technologically advanced and highly organized industrial societies on earth, Japan, chose to stop growing two decades ago -- just as many people feared that it was about to displace the United States as the world's dominant power.

Many economists, including Krugman and Fed chairman Ben Bernanke, have blamed Japan's economic decline on the mistaken policies of the Japanese government and the timidity of the Bank of Japan. However, different Japanese governments have tried a variety of policies, including massive fiscal stimulus, but they have run against stubborn unwillingness by Japanese consumers to spend. In fact, the Japanese, despite their great household wealth, are forming fewer and fewer households, buying fewer and fewer cars and appliances and in general show a predilection for economic decline rather than an ambition for more growth.

At least for now, the United States may have run out of sources of growth. Regardless of how long the pause in growth lasts, it is probably imprudent to run up huge debt in the hope that government spending alone will spur the economy to the kind of growth that was seen during the optimistic 1950s and early 1960s. The possibility of Japan-style stagnation in coming years can't be dismissed out of hand. If politicians in Washington listen to Krugman and other Keynesians and pump another trillion dollars into the economy using money they don't have, they risk ending up with Japanese-style debt, which currently measures more than 200 percent of GDP.

Alexei Bayer is an economist and author based in New York City.

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